CHAPTER 2

BASIC COST MANAGEMENT CONCEPTS

QUESTIONS FOR WRITING AND DISCUSSION
1. A cost object is any item for which costs are
measured and assigned, including such
things as products, plants, projects,
departments, customers, and activities.

products on three important dimensions:

intangibility, perishability, and inseparability.
Intangibility means that buyers of services
cannot see, feel, taste, or hear a service
before it is bought. Perishability means that
services cannot be stored. Inseparability
means that producers of services and
buyers of services must be in direct contact
(not true for tangible products).

2. An activity is a basic unit of work performed

within an organization. Examples include
materials handling, inspection, purchasing,
billing, and maintenance.
3. Direct costs are costs that can be easily and
accurately traced to a cost object. An
indirect cost is a cost that cannot be easily
traced to cost objects.

9. Three examples of product cost definitions

are value-chain, operating, and traditional
definitions. The value-chain definition
includes cost assignments for research and
development, production, marketing, and
customer service (all value-chain activities).
Operational product costs include all costs
except for research and development.
Traditional product costs include only
production costs. Different cost definitions
are needed because they serve different
managerial objectives.

4. Traceability is the ability to assign a cost

directly to a cost object in an economically
feasible way using a causal relationship.
5. Allocation is the assignment of indirect costs
to cost objects based on convenience or
assumed linkages.
6. Driver tracing is the use of drivers to trace
costs to cost objects. Often, this means that
costs are first traced to activities using
resource drivers and then to cost objects
using activity drivers.

10.

The three cost elements are direct

materials, direct labor, and overhead.

11. The income statement for a service firm

does not need a supporting cost of goods
manufactured schedule. Since services
cannot be stored, the cost of services
produced equals the cost of services sold
(not necessarily true for a manufacturing
firm).

7. Tangible products are goods that are made

by converting raw materials through the use
of labor and capital inputs.
8. A service is a task or activity performed for
a customer or an activity performed by a
customer using an organizations products
or facilities. Services differ from tangible

14

EXERCISES

21
a.
b.
c.
d.
e.

Allocation
Direct tracing
Allocation
Direct tracing
Driver tracing; potential driver
machine hours
f. Direct tracing
g. Driver tracing; potential driver
number of square feet occupied

h. Direct tracing
i. Driver tracing; potential driver
number of orders
j. Direct tracing
k. Allocation
l. Driver tracing; potential driver
number of employees
m. Direct tracing
n. Allocation

14

22
a. Value-chain. The price needs to cover all product costs, including the costs
of developing, selling, and servicing.
b. Manufacturing. This approach is mandated for external reporting.
c. Value-chain. Product mix decisions should consider all costs, and the mix
that is the most profitable in the long run should be selected.
d. Operating. The designs should be driven by the effect they have on
production, marketing, and servicing costs. Thus, the operating cost
definition is the most relevant.
e. Manufacturing. This approach is mandated for external reporting.
f. Operating. Research and design costs are not relevant for a price decision
involving an existing product. Production, marketing, and servicing costs are
relevant, however.
g. Operating. Any special order should cover its costs, which potentially include
production, marketing, and servicing costs.
h. Value-chain. This is a strategic decision and involves activities and costs
throughout the entire value chain.
i. Operating. At this point, the costs of design and development are sunk costs;
the decision to produce should consider the costs of production, marketing,
and servicing the product.

23
1.

Direct materials used = $50,800 + $150,000 $21,500 = $179,300

2.

Direct materials..........................................................
Direct labor.................................................................
Overhead....................................................................
Total manufacturing cost..........................................
Add: Beginning WIP..................................................
Less: Ending WIP......................................................
Cost of goods manufactured...................................

$ 179,300
200,000
324,700
$ 704,000
58,500
(23,500)
$ 739,000

Unit cost of goods manufactured = $739,000/100,000 = $7.39

3.

Direct labor = $7.39 $1.70 $3.24 = $2.45

Prime cost = $1.70 + $2.45 = $4.15
Conversion cost = $2.45 + $3.24 = $5.69

24
1.

Beginning inventory + Purchases Ending inventory = DM used

$21,000 + $352,000 Ending inventory = $300,000
Ending inventory = $73,000

2.

Units in beginning finished goods inventory = $4,680/$5.85 = 800

Beginning inventory
Inventory produced
Inventory available
Less: ending inventory
Inventory sold

800
12,000
12,800
(X)
8,900

800 + 12,000 X = 8,900

X = 3,900
3.

Cost of goods manufactured = $50,000 +$93,000 $18,750 = $124,250

4.

32 = DL + OH
19.5 = DM + DL
(2)
39.5 = DM + DL + OH

(1)
(3)

(3) (2): 39.5 19.5 = (DM + DL + OH) (DM + DL); OH = 39.5 19.5 = 20
Replace OH in (1): 32 = DL + 20; DL = 32 20 = 12
Replace DL in (2): 19.5 = DM + 12; DM = 7.5
Alternatively,
(3) (1): 39.5 32 = (DM + DL + OH) (DL + OH); DM = 7.5
5.

Total manufacturing costs added + BWIP EWIP = COGM

$156,900 + $60,000 EWIP = $125,000
EWIP = $91,900
Prime cost + Overhead = Total manufacturing costs added
$90,000 + Overhead = $156,900
Overhead = $66,900

25
1.

Beckman Company
Statement of Cost of Goods Manufactured
For the Month of November
Direct materials:
Beginning inventory..................................
Add: Purchases..........................................
Materials available.....................................
Less: Ending inventory.............................
Direct materials used in production........
Direct labor........................................................
Manufacturing overhead...................................
Total manufacturing costs added....................
Add: Beginning work in process.....................
Less: Ending work in process.........................
Cost of goods manufactured...........................

2.

$ 48,500
70,000
$118,500
(15,900)
$ 102,600
22,000
216,850
$ 341,450
10,000
(6,050)
$ 345,400

Beckman Company
Statement of Cost of Goods Sold
For the Month of November
Cost of goods manufactured....................................................
Add: Beginning finished goods inventory..............................
Cost of goods available for sale..............................................
Less: Ending finished goods inventory..................................
Cost of goods sold....................................................................

$ 345,400
10,075
$ 355,475
(8,475)
$ 347,000

26
1.

Units in ending finished goods = 6,000 + 270,000 274,000

= 2,000
Costs of finished goods ending inventory = 2,000 $5.10* = $10,200
*Since the unit cost of beginning finished goods and the unit cost of current
production both equal $5.10, the unit cost of ending finished goods must
also equal $5.10. The equality of the unit cost also avoids the problem of
cost flow assumptions (e.g., FIFO, LIFO).

2.

Photo-Dive, Inc.
Statement of Cost of Goods Sold
For the Year Ended December 31
Cost of goods manufactured ($5.10 270,000)......................
Add: Beginning finished goods inventory..............................
Goods available for sale...........................................................
Less: Ending finished goods inventory..................................
Cost of goods sold....................................................................

3.

$1,377,000
30,600
$1,407,600
(10,200)
$1,397,400

Photo-Dive, Inc.
Income Statement: Absorption Costing
For the Year Ended December 31
Sales (274,000 $8)..........................................
Cost of goods sold............................................
Gross margin.....................................................
Less operating expenses:
Research and development .....................
Commissions (274,000 $0.25)................
Advertising copayments...........................
Administrative expenses...........................
Operating Income..............................................

$2,192,000
1,397,400
$ 794,600
$ 70,000
68,500
36,000
83,000

(257,500)
$ 537,100

27
1.

Thomson Company
Statement of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Beginning inventory...................................
Add: Purchases.........................................
Freight-in on materials..................
Materials available.....................................
Less: Ending inventory...........................
Direct materials used.................................
Direct labor.........................................................
Manufacturing overhead:
Material handling........................................
Supplies......................................................
Utilities........................................................
Supervision and indirect labor...............
Total overhead costs.................................
Total manufacturing costs added....................
Add: Beginning work in process.....................
Less: Ending work in process.........................
Cost of goods manufactured...........................

2.

$ 47,000
160,400
1,000
$208,400
(17,000)
$ 191,400
371,500
$ 26,750
37,800
46,000
190,000
300,550
$ 863,450
201,000
(98,000)
$ 966,450

Thomson Company
Statement of Cost of Goods Sold
For the Year Ended December 31
Cost of goods manufactured....................................................
Add: Beginning finished goods inventory..............................
Cost of goods available for sale..............................................
Less: Ending finished goods inventory..................................
Cost of goods sold....................................................................

$ 966,450
28,000
$ 994,450
(45,200)
$ 949,250

28
1.

Beginning inventory, materials................................

+ Purchases...........................................................
Ending inventory, materials............................
Materials used in production...................................

2.

Prime cost = $9,650 + $18,570 = $28,220

3.

Conversion cost = $18,570 + $15,000 = $33,570

4.

Direct materials..........................................................
Direct labor.................................................................
Overhead....................................................................
Cost of services.........................................................

5.

850
9,750
(950)
$ 9,650

$ 9,650
18,570
15,000
$ 43,220

Compufix
Income Statement
For the Month Ended August 31
Sales revenues...........................................................................
Cost of services sold.................................................................
Gross margin..............................................................................
Operating expenses:
Advertising...........................................................................
Administrative costs...........................................................
Operating Income......................................................................

$ 60,400
43,220
$ 17,180
(5,000)
(3,000)
$ 9,180

29
1.

Thomas is interested in the manufacturing costs of glaxane. In particular, the

costs of direct materials, direct labor, and overhead will be calculated to
budget for glaxane production.

2.

Theo will be concerned with all costs along the value chain. Clearly, the
after-sale costs will be an important factor in pricing since the potential for
fatal side effects will lead to both lawsuits and the withdrawal of glaxane
from the market. However, Theo must also be concerned with the costs of
research, development, and production since pharmaceutical companies
attempt to link all of these costs to a drug to justify their pricing strategies.

3.

Tamara will be primarily concerned with the overall research and

development costs and the eventual revenue from the successful drugs. Any
individual potential drug can turn out to have no value as long as some drug
projects are successful and can justify the total efforts.

210
1.

Given the description provided, we can conclude that Bose uses a

functional-based cost management system. First, evidence exists that
product costs are only determined by production costs. Apparently, the
financial accounting system is driving the type of product cost information
being produced. Second, only direct labor hours, a unit-based driver, are
used to assign overhead costs. Since many overhead costs are likely to be
caused by non-unit-based drivers, this also suggests a strong reliance on
allocation for cost assignment. Third, the company attempts to control costs
by encouraging departmental managers to meet budgeted levels of
expenditures. The focus is on departmental performance rather than systemwide performance. Further, departmental performance is measured only by
financial instruments.

2.

Product costing accuracy can be improved by placing more emphasis on

tracing and less on allocation. Enough information is provided to reveal that
the two products make quite different demands on certain activities. Setup,
receiving, and purchasing resources are clearly consumed differently by the
two products. Furthermore, it is doubtful that direct labor hours would have
anything to do with the two products patterns of resource consumption for
these three activities. Thus, using activity drivers that better reflect the
differential resource consumption would improve the cost assignments.
Bose would need to assign costs to the activities using direct tracing and
resource drivers and then assign the cost of the activities to the two
products using activity drivers. Bose also should consider the possibility of
computing differentmore managerially relevantproduct costs such as
value-chain costs and operational costs.

3.

Bose would need to change its control focus from managing costs to
managing activities. This also would entail a shift in emphasis from
departmental performance maximization to system-wide performance
maximization. To bring about this change, Bose will need to provide detailed
information concerning activities. Since activities cause costs, managing
activities is a more logical approach to controlling costs.

211
1.

Direct materials used = $52,700 + $270,000 $42,700 = $280,000

2.

Direct materials..........................................................
Direct labor.................................................................
Overhead....................................................................
Total manufacturing cost..........................................
Add: Beginning WIP..................................................
Less: Ending WIP......................................................
Cost of goods manufactured...................................

280,000
304,000
506,000
$ 1,090,000
25,000
(50,000)
$ 1,065,000

Unit cost of goods manufactured = $1,065,000/25,000 = $42.60

3.

Overhead per unit = $42.60 $11.00 $12.00 = $19.60

Prime cost = $11 + $12 = $23
Conversion cost = $12.00 + $19.60 = $31.60

212
1.

2.

Cost of goods manufactured ..................................

Add: Beginning finished goods inventory............
Less: Ending finished goods inventory................
Cost of goods sold....................................................

$ 1,065,000
75,000
(140,000)
$ 1,000,000

Huebert Company
Income Statement
For the Year Ended December 31
Sales............................................................................................
Cost of goods sold....................................................................
Gross margin..............................................................................
Less: Selling and administrative expense..............................
Operating Income......................................................................

$ 1,940,000
1,000,000
$ 940,000
(288,300)
$ 651,700

PROBLEMS
213
1.

The decision was made assuming that the fixed cost pool would remain
unchanged. What management failed to realize was that additional demands
on activities would be made by the new product line. Their failure to
recognize this was due to the fact that they did not understand that costs can
be driven by factors that are unrelated to the number of units produced. For
example, materials handling costs are apparently driven by the number of
moves, inspection costs by the number of batches, purchasing costs by the
number of orders, and accounting costs by the number of transactions.
Demand for these activities increased and so supply of the activities had to
be increased; each activity evidently did not have enough idle capacity to
handle the increased demands.

2.

An activity-based cost management system provides information about both

unit-based and non-unit-based drivers and is concerned with tracing these
costs to the individual product lines. Using this system, the need for
additional resources would have been revealed, leading to a better decision.
Whether or not the company should adopt the activity-based system
depends on the costs of making bad decisions versus the cost of
implementing the more accurate system. Based on the reference to
competition and the experience with the new product lines, an ABC system
may very well be appropriate. One difference between an ABC and a
functional-based cost system has already been mentioned, i.e., the use of
additional drivers in an ABC system. The ABC system emphasizes tracing
and usually produces greater product costing accuracy. Broader and more
flexible product cost definitions are also available in this system. An ABC
system also focuses on managing activities and stresses system-wide
performance maximization (as opposed to the traditional approaches of
managing costs and maximizing individual unit performance). Finally, it
should also be mentioned that an ABC system uses both financial and
nonfinancial operational measures of performance.

214
Functional-based control system:
Actions
a
b
d
g
j
l
o

Justification
Performance, organizational subunit; managing costs
Rewards manager for subunit performance
Emphasizes performance of organizational subunit
Emphasis on controlling costs
Reward based on controlling costs (subunit performance)
Emphasis on controlling costs
Emphasis on subunit performance; controlling costs

Activity-based control system:

Actions
c
e
f
h
i
k
m
n

Justification
Activity-based cost used as input for activity control
Emphasis on activity analysis
Emphasis on managing activities (activity analysis)
Managing activities
Driver analysis
Driver analysis; activity management
Nonfinancial measure of performance
Driver analysis, activity performance

215
1.

Jordan Company
Statement of Costs of Goods Manufactured
For the Year Ended December 31
Direct materials:
Beginning inventory........................................
Add: Purchases...............................................
Materials available...........................................
Less: Ending inventory...................................
Direct materials used......................................
Direct labor..............................................................
Manufacturing overhead:
Insurance on factory.......................................
Indirect labor....................................................
Depreciation, factory building.......................
Depreciation, factory equipment...................
Property taxes on factory...............................
Utilities, factory...............................................
Total manufacturing costs added.........................
Add: Beginning work in process..........................
Less: Ending work in process...............................
Cost of goods manufactured................................

2.
3.

380,000
1,675,000
$ 2,055,000
(327,000)
$ 1,728,000
2,000,000
$

200,000
790,000
1,100,000
630,000
65,000
150,000

2,935,000
$ 6,663,000
450,000
(750,000)
$ 6,363,000

Unit cost = $6,363,000/150,000 = $42.42

Jordan Company
Income Statement: Absorption Costing
For the Year Ended December 31
Sales (141,000* $50)............................................
Cost of goods sold:
Cost of goods manufactured.........................
Add: Beginning finished goods inventory....
Goods available for sale.................................
Less: Ending finished goods inventory......
Gross margin...........................................................
Less:
Research and development............................
Salary, sales supervisor..................................
Commissions, salespersons..........................
Administrative expenses..............................
Income before taxes...............................................
*2,500 + 150,000 11,500 = 141,000 units sold.

$ 7,050,000
$ 6,363,000
107,500
$ 6,470,500
489,000
$

5,981,500
$ 1,068,500

120,000
85,000
370,000
390,000
$

965,000
103,500

216
1.

Direct materials..........................................................
Direct labor.................................................................
Manufacturing overhead...........................................
Total manufacturing costs added............................
Add: Beginning work in process..............................
Less: Ending work in process..................................
Cost of goods manufactured....................................
a

$ 75,000
15,000a
345,000a
$ 435,000
20,000b
(40,000)b
$ 415,000

Conversion cost = 4 Prime cost

$360,000 = 4(Direct materials + Direct labor)
$360,000 = 4($75,000 + Direct labor)
Direct labor = $15,000
Conversion cost = Overhead + Direct labor
$360,000 = Overhead + $15,000
Overhead = $360,000 $15,000
Overhead = $345,000

2.

Ending WIP = 2 Beginning WIP

$435,000 + Beg. WIP (2 Beg. WIP) = $415,000
Beginning WIP = $20,000; Ending WIP = 2 $20,000 = $40,000

Cost of goods manufactured...................................

Add: Beginning finished goods.............................
Cost of goods available for sale..............................
Less: Ending finished goods.................................
Cost of goods sold....................................................
*Ending finished goods = $431,500 $373,500 = $58,000
**COGS = 0.90 $415,000 = $373,500

$ 415,000
16,500
$ 431,500
(58,000)*
$ 373,500**

217
1.

Young, Coopers, and Touche

Statement of Cost of Services Sold
For the Year Ended June 30
Direct materials:
Beginning inventory .
Add: Purchases ............
Less: Ending inventory ...
Direct materials used......................................................
Direct labor..............................................................................
Overhead.................................................................................
Total service costs added......................................................
Add: Beginning work in process...........................................
Less: Ending work in process..............................................
Cost of services sold..............................................................

$ 20,000
40,000
(14,000)*
$ 46,000*
800,000
100,000
$ 946,000
78,000
(134,000)
$ 890,000

*Because all other data for the statement are given, you can work backward
from the cost of services sold to get the direct materials used.
2.

3.

The dominant cost is direct labor (for the 10 professionals). Although labor is
the major cost of providing many services, it is not always the case. For
example, the dominant cost for some medical services may be overhead
(e.g., CAT scans). In some services, the dominant cost may be materials (e.g.,
funeral services).
Young, Coopers, and Touche
Income Statement
For the Year Ended June 30
Sales (2,000 $650)..........................................
Cost of services sold........................................
Gross margin.....................................................
Less operating expenses:
Selling expenses........................................
Administrative expenses...........................
Operating Income..............................................

$1,300,000
890,000
$ 410,000
$53,000
69,000

122,000
$ 288,000

217
4.

Concluded

Services have three attributes that are not possessed by tangible products:
(1) intangibility, (2) perishability, and (3) inseparability. Intangibility means
that the buyers of services cannot see, feel, hear, or taste a service before it
is bought. Perishability means that services cannot be stored. Therefore,
there will never be any finished goods inventories, making the cost of
services produced equal to the cost of services sold. Inseparability means
that providers and buyers of services must be in direct contact for an
exchange to take place.
The average cost of preparing one tax return last year was $445
($890,000/2,000 returns). However, it will be difficult for YCT to use this figure
in budgeting. Some of its accountants are no doubt more experienced than
others, capable of completing a return in less time and with less research.
The returns themselves differ in complexity. In addition, the seemingly
continual changes in the tax law may affect certain of their clients more than
others, making those clients returns more difficult to prepare.

218
Answers will vary.

219
Answers will vary.