AGENDA

Exam:
Location Toldo Building Room 200
Chapter 2
Case for Chapter 2
Start Chapter 3
Next Week:
Chapter 3 and Case
Chapter 4 and Case
 CHAPTER 2:
Cost Terms,
Concepts and
Classifications

Prepared by
Shannon Butler,
CPA, CA
Carleton
University
 Learning Objectives
1 Identify each of the three basic manufacturing cost
categories.
2 Distinguish between product costs and period
costs.
3 Prepare an income statement, including the
calculation of cost of goods sold.
4 Prepare a schedule of cost of goods manufactured.
5 Explain the differences between variable and fixed
costs.
6 Identify the differences between direct and indirect
costs.
7 Describe the cost classifications used in making
decisions: differential costs, opportunity costs, and
sunk costs.
© 2021 McGraw-Hill Limited 2-3
 Manufacturing Costs

Manufacturing companies
typically divide manufacturing
costs into three broad categories:

• Direct Materials
• Direct Labour
• Manufacturing Overhead

© 2021 McGraw-Hill Limited 2-4

 Direct Materials
• Materials that go into the final product are
called raw material.
• Raw materials may include both direct and
indirect materials. ‫ﺟزء ﻻﯾﻧﻔﮏ ﻣﺣﺻول ﺗوﻟﯾدی‬
• Direct materials are those materials that
become an integral part of the product and
that can be physically and conveniently
traced directly to it.
• Indirect materials either can not or it is not
worth the expense or effort to trace the
costs to the end product. Indirect materials
are included as part of manufacturing
‫ ھزﯾﻧﮫ ﻣواد ﻏﯾر ﻣﺳﺗﻘﯾم ارزش ﭘﯾﮕﯾری ﻧداره و در ﺑﺧش ﺳرﺑﺎر ﺗوﻟﯾد‬manufacturing overhead‫ﻣﺣﺎﺳﺑﮫ ﻣﯾﺷﮫ‬
overhead. © 2021 McGraw-Hill Limited 2-5
 Direct Labour
• Direct Labour consists of labour costs
that can be easily (physically and
conveniently) traced to individual units
of product. ‫ﻧﯾرو ﻣﺳﺗﻘﯾم ﺑﺧﺷﯽ از ھزﯾﻧﮫ ﻧﯾرو ھﺳت ﮐﮫ ﭼون وﺟود ﻓﯾزﯾﮑﯽ داره‬
‫ﻗﺎﺑﻠﯾت ﻣﺣﺎﺳﺑﮫ ﺟداﮔﺎﻧﮫ دارد‬

• Labour costs that cannot be physically

traced to the creation of products (or it
would be costly or inconvenient to
trace) are called indirect labour and
are treated as part of manufacturing
overhead.‫ھزﯾﻧﮫ ﻧﯾرو ﮐﮫ ﻗﺎﺑﻠﯾت ﻟﻣس ﻓﯾزﯾﮑﯽ و راﺣﺗﯽ‬
‫ ﺟزء‬،‫ در ﻣﺣﺻول ﻧداره‬manufacturing overhead
© 2021 McGraw-Hill Limited 2-6
Manufacturing Overhead
Manufacturing Overhead includes all
costs of manufacturing except direct
material and direct labour.
Examples: Indirect materials and indirect
labour

© 2021 McGraw-Hill Limited 2-7

 Classifications of Costs

Manufacturing costs are often

classified as follows:

Direct Direct Manufacturing

Material Labour Overhead

Prime Conversion ‫ھزﯾﻧﮫ‬

Cost Cost ‫ﺗﺑدﯾل‬

© 2021 McGraw-Hill Limited 2-8

 Overtime Premiums
• The overtime premiums for all
factory workers are usually
considered to be part of
manufacturing overhead.

• Product specific overtime premiums

are part of direct labour.

© 2021 McGraw-Hill Limited 2-9

Non-Manufacturing Costs
• Marketing or Selling Costs: Costs
necessary to get the order and
deliver the product.

• Administrative Costs: All executive,

organizational, and clerical costs.
‫ھزﯾﻧﮫ دﻓﺗری‬

© 2021 McGraw-Hill Limited 2-

 Product Costs Versus Period Costs
‫ ھزﯾﻧﮫ ﻓروﺷش در‬،‫ﻣوﺟودی ﻗﺑل از ﻓروش در ﺗرازﻧﺎﻣﮫ ھﺳت اﻣﺎ ﺑﻌد ﻓروش‬
‫ﺻورت ﺣﺳﺎب درآﻣد‬

Product costs Period costs include

include direct all selling costs and
materials, direct administrative
labour, and costs.
manufacturing
overhead.
‫ﻣوﺟودی‬ Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement

© 2021 McGraw-Hill Limited 2-11

 Summary of Cost Terms
Exhibit 2-1

Direct material + direct labour =prime cost

direct labour + manufacturing oveerhead=conversion cost

© 2021 McGraw-Hill Limited 2-

 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.
© 2021 McGraw-Hill Limited 2-13
 Quick Check 

Which of the following costs would be considered a

period rather than a product cost in a manufacturing
company?

Answer:
B. Property taxes on corporate
headquarters.
E. Sales commissions.

© 2021 McGraw-Hill Limited 2-14

 Cost Classifications on
Financial Statements
• Financial statements prepared by a
manufacturing company are more complex
than the statements prepared by a
merchandising or service company.
• Manufacturing companies must account for
the production of its goods as well as for the
marketing of them.
• Manufacturing companies therefore have
many costs that do not exist in a
merchandising or service company.
• Merchandising companies simply purchase
goods from suppliers for resale to customers.
© 2021 McGraw-Hill Limited 2-15
 Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
• Cash • Cash
• Receivables • Receivables
• Prepaid • Prepaid
Expenses Expenses
• Merchandise • Inventories
Inventory • Raw Materials
• Work in Process
• Finished Goods

© 2021 McGraw-Hill Limited 2-16

 Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
• Cash • Cash
• Receivables • Receivables
• Prepaid Materials
• Prepaid waiting to
be processed.
Expenses Expenses
• Merchandise • Inventories
Inventory • Raw Materials
• Work in Process
• Finished Goods

Completed products
awaiting sale.
© 2021 McGraw-Hill Limited 2-17
 The Income Statement
Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for merchandisers.

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

© 2021 McGraw-Hill Limited 2-18

 Basic Equation for
Inventory Accounts

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

© 2021 McGraw-Hill Limited 2-19

 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.
© 2021 McGraw-Hill Limited 2-20
 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?

Answer: $1,000 + $100 = $1,100

B. $ 800.$1,100 - $300 = $800

© 2021 McGraw-Hill Limited 2-21

Schedule of Cost of Goods
Manufactured
• Calculates the cost of raw material,
direct labour and manufacturing
overhead used in production.

• Calculates the manufacturing costs

associated with goods that were
finished during the period.

© 2021 McGraw-Hill Limited 2-22

Product Cost Flows

As items are removed from raw

materials inventory and placed
into the production process,
they are
called direct materials.
© 2021 McGraw-Hill Limited 2-23
Product Cost Flows

© 2021 McGraw-Hill Limited 2-24

Product Cost Flows

All manufacturing costs

incurred during the period are
added to the beginning balance
of work in process.

© 2021 McGraw-Hill Limited 2-25

 Product Cost Flows

Costs associated with the goods

that are completed during the
period are transferred to
finished goods inventory.

© 2021 McGraw-Hill Limited 2-26

Product Cost Flows

© 2021 McGraw-Hill Limited 2-27

 Manufacturing Cost Flows
Exhibit 2-5

© 2021 McGraw-Hill Limited 2-28

 An Example of Manufacturing
Cost Flows
Exhibit 2-6

© 2021 McGraw-Hill Limited 2-29

 SUMMARY OF COST CLASSIFICATIONS
PURPOSE OF COST COST CLASSIFICATIONS
CLASSIFICATION
Preparing external financial Product costs (inventoriable)
statements Direct materials
Direct labour
Manufacturing overhead
Period costs (expensed)
Non-manufacturing costs
Marketing or selling costs
Administrative costs
Predicting cost behaviour in response to Variable cost (proportional to
changes in activity activity)
Fixed cost (constant in total)
Assigning costs to cost objects such as Direct cost (can easily be traced)
departments or products
•Indirect cost (cannot easily be
traced;
must be allocated)
Making decisions Differential cost (differs between
alternatives)
Sunk cost (past cost not affected by
a decision)
© 2021 McGraw-Hill Limited 2-30
 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
© 2021 McGraw-Hill Limited 2-31
 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?

Answer:
C. $280,000
© 2021 McGraw-Hill Limited 2-32
 Quick Check 

Direct materials used in production totalled

$280,000. Direct labour 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.

© 2021 McGraw-Hill Limited 2-33

 Quick Check 

Direct materials used in production totalled

$280,000. Direct labour was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
Answer:
B.$835,000

© 2021 McGraw-Hill Limited 2-34

 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.
© 2021 McGraw-Hill Limited 2-35
 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?

Answer:
C.$ 760,000

© 2021 McGraw-Hill Limited 2-36

 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.
© 2021 McGraw-Hill Limited 2-37
 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?
$130,000 + $760,000 = $890,000
Answer:
$890,000 – $150,000 = $740,000
B. $740,000.

© 2021 McGraw-Hill Limited 2-38

 Cost Classifications for
Predicting Cost Behaviour
• 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.
© 2021 McGraw-Hill Limited 2-39
 Variable Cost

Your total texting bill is based on

how many texts you send.
Total Texting Bill

Number of Texts
Sent
© 2021 McGraw-Hill Limited 2-40
Variable Cost Per Unit

The cost per text sent is constant

at
5 cents per text message.
Cost Per Text Sent

Number of Texts
Sent
© 2021 McGraw-Hill Limited 2-41
The Activity Base (Cost Driver)

Units Machine
produced hours

A measure of
what causes the
incurrence of a
variable cost

Miles Labour
driven hours
© 2021 McGraw-Hill Limited 2-42
 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
© 2021 McGraw-Hill Limited 2-43
 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
© 2021 McGraw-Hill Limited 2-44
 Relevant Range

• The relevant range is the range

of activity within which the
assumptions about variable and
fixed cost behaviour are valid.

© 2021 McGraw-Hill Limited 2-45

 Mixed Costs

• Some costs contain variable and

fixed cost elements; these are
called mixed costs.

© 2021 McGraw-Hill Limited 2-46

Summary of Variable and
Fixed Cost Behaviour

© 2021 McGraw-Hill Limited 2-47

 Quick Check 

Which of the following costs would be variable

with respect to the number of cones sold at a
Baskin-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.
© 2021 McGraw-Hill Limited 2-48
 Quick Check 

Which of the following costs would be variable

with respect to the number of cones sold at a
Baskin-Robbins shop? (There may be more
than one correct answer.)

Answer:
C. The cost of ice cream.
D. The cost of napkins for customers.
© 2021 McGraw-Hill Limited 2-49
 Assigning Costs to Cost
Objects
• Cost Objects: any unit of analysis for
which cost data are desired; including
products, customers, jobs, and
organizational subunits.
• For assigning costs to cost objects,
costs are classified as either direct or
indirect.

© 2021 McGraw-Hill Limited 2-50

 Assigning Costs to Cost
Objects
• Direct costs: Costs that can be easily and
conveniently traced to a unit of product or
other cost object.
• Examples: direct material and direct
labour
• Indirect costs: Costs that cannot be easily
and conveniently traced to a unit of
product or other cost object.
• Example: manufacturing overhead

© 2021 McGraw-Hill Limited 2-51

 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.

© 2021 McGraw-Hill Limited 2-52

 Differential Cost and
Revenue
• A difference in cost between any two
alternatives is known as a differential cost.
• A difference in revenues between any two
alternatives is known as differential revenue.
• A differential cost is also known as an
incremental cost (an increase in cost from
one alternative to another).

© 2021 McGraw-Hill Limited 2-53

 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.

© 2021 McGraw-Hill Limited 2-54

 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: 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.
© 2021 McGraw-Hill Limited 2-55
 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.
© 2021 McGraw-Hill Limited 2-56
 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?

Answer:
A. Yes, the cost of the train ticket is relevant.

© 2021 McGraw-Hill Limited 2-57

 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 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.

© 2021 McGraw-Hill Limited 2-58

 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 annual cost of licensing your car relevant
in this decision?

Answer:
B. No, the licensing cost is not relevant.

© 2021 McGraw-Hill Limited 2-59

 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.

© 2021 McGraw-Hill Limited 2-60

 Quick Check 

Suppose that your car could be sold now for

$5,000. Is this a sunk cost?

Answer:
B. No, it is not a sunk cost.

© 2021 McGraw-Hill Limited 2-61

Summary of the Types of
Cost Classifications
• Financial reporting
• Predicting cost behaviour
• Assigning costs to cost objects
• Decision making

© 2021 McGraw-Hill Limited 2-62

End of Chapter Summary
Part 1
• Manufacturing costs can be divided into three
categories: direct materials, direct labour, and
manufacturing overhead.
• Non-manufacturing costs are classified as
either marketing/selling costs or administrative
costs.
• When valuing inventories and determining
expenses for the balance sheet and income
statement, costs are classified as either
product costs or period costs.
© 2021 McGraw-Hill Limited 2-63
End of Chapter Summary
Part
• Cost of goods sold 2 by adding
is calculated
cost of goods manufactured to beginning
finished goods inventory and then deducting
the ending finished goods inventory.
• To predict cost behaviour, managers
commonly classify costs into two categories,
variable and fixed.
• To assign costs to cost objects such as
products or departments, costs are classified
as direct or indirect.
© 2021 McGraw-Hill Limited 2-64
Case 1 – Chapter 2
BSMM 8110 F2022
Cost of Goods and Cost Behaviour
The following is the first quarter ending June 30, 2021 for Liberal-NDP
Purchase of Raw Materials $360,000
Co-Op Inc.: Raw Materials Inventory - $40,000
Beginning
Raw Materials Inventory - Ending $68,000
Depreciation, Factory $168,000
Insurance, Factory $20,000
Direct Labour $240,000
Maintenance, Factory $120,000
Administrative Expenses $280,000
Sales $1,800,000
Utilities, factory $108,000
Supplies, Factory $4,000
Selling Expenses $320,000
Indirect Labour $260,000
Work in process inventory, $28,000
beginning
Work in process inventory, ending $120,000
Finished Goods inventory, $40,000
beginning
Finished Goods inventory, ending $160,000
Cost of Goods and Cost Behaviour
Required:
1.Prepare a Schedule of Costs of Goods Manufactured
Cost of Goods and Cost Behaviour
Liberal-NDP Co-Op Inc.
Schedule of Cost of Goods Manufactured
For the quarter ended J une 30, 2021
Direct materials:
Raw materials inventory, beginning................ $ 40,000
Add: Purchases of raw materials.................... 360,000
Raw materials available for use...................... 400,000
Deduct: Raw materials inventory, ending ....... 68,000
Raw materials used in production .................. $ 332,000
Direct labour ................................................... 240,000
Manufacturing overhead:
Depreciation, factory..................................... 168,000
Insurance, factory......................................... 20,000
Maintenance, factory..................................... 120,000
Utilities, factory............................................. 108,000
Supplies, factory ........................................... 4,000
Indirect labour .............................................. 260,000
Total overhead costs ....................................... 680,000
Total manufacturing costs................................ 1,252,000
Add: Work in process inventory, beginning ....... 28,000
1,280,000
Deduct: Work in process inventory, ending ....... 120,000
Cost of goods manufactured ............................ $1,160,000
Cost of Goods and Cost Behaviour
Direct materials:
Raw materials inventory, beginning................ $
Add: Purchases of raw materials ....................
Raw materials available for use......................
Deduct: Raw materials inventory, ending .......
Raw materials used in production .................. $
Direct labour ...................................................
Manufacturing overhead:
Depreciation, factory.....................................
I nsurance, factory.........................................
Maintenance, factory.....................................
Utilities, factory.............................................
Supplies, factory ...........................................
I ndirect labour ..............................................
Total overhead costs .......................................
Total manufacturing costs ................................
Add: Work in process inventory, beginning .......

Deduct: Work in process inventory, ending .......

Cost of goods manufactured ............................
Cost of Goods and Cost Behaviour
Required:
2. Prepare an Income Statement
Cost of Goods and Cost Behaviour
Liberal-NDP Co-Op Inc.
Statement of Earnings
For the quarter ended June 30, 2021

Sales $1,800,000
Cost of goods sold:
Finished goods inventory, beginning $ 40,000
Add: Cost of goods manufactured 1,160,000
Goods available for sale 1,200,000
Deduct: Finished goods inventory, ending 160,000 1,040,000
Gross margin 760,000
Selling and administrative expenses:
Selling expenses 320,000
Administrative expenses 280,000 600,000
Operating income $ 160,000
Cost of Goods and Cost Behaviour
Required:
3. Assume the company produced 10,000 units during the
coming year. What was the average cost per unit for direct
labour? What was the average cost per unit for factory
insurance?
Cost of Goods and Cost Behaviour
3.
Direct labour: $240,000 ÷ 10,000 units = $24.00 per unit.
Insurance: $20,000 ÷ 10,000 units = $2.00 per unit.
Cost of Goods and Cost Behaviour
Required:
4. Assume the company expects to produce 12,000 units of
product during the coming year. What average costs per unit
and what total cost would you expect the company to incur
for direct materials at this level of activity. For factory
insurance? (In preparing your answer, assume that direct
materials is a variable cost and depreciation is a fixed cost;
also assume that depreciation is calculated on a straight-line
basis.)
Cost of Goods and Cost Behaviour
4.
Direct materials:
Unit cost: 332,000/10000= $33.20
Total cost: 12,000 units × $33.20 per unit = $398,400.
Insurance:
Unit cost: $20,000 ÷ 12,000 units = $1.67 per unit
(rounded).
Total cost: $20,000 (unchanged) fixed cost
Cost of Goods and Cost Behaviour
Required:
5. As the manager responsible for production costs, explain to
the president any difference in the average costs per unit
between (Q3) and (Q4) above.
Cost of Goods and Cost Behaviour
5.
Unit cost for insurance dropped from $2.00 to $1.67, because
of the increase in production between the two years. Since
fixed costs do not change in total as the activity level changes,
they will decrease on a unit basis as the activity level rises.
Cost of Goods and Cost Behaviour
Required:
6. Assuming the company produced 20,000 fully and partially
finished units during the year, determine the cost components
of the finished goods inventory, which is composed of 4,000
finished units.
Cost of Goods and Cost Behaviour
6.

If the company produced 20,000 units, then the following costs would appear in
inventory:

Direct materials ($332,000/20,000)*4,000 units = $ 66,400

Direct labour ($240,000/20,000)* 4,000 units = 48,000
Manufacturing overhead ($680,000/20,000) * 4,000 units = 136,000
Total $ 250,400
Cost of Goods and Cost Behaviour