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MANAGERIAL ACCOUNTING
Eighth Canadian Edition
GARRISON, CHESLEY, CARROLL, WEBB

Prepared by: Robert G. Ducharme, MAcc, CA University of Waterloo, School of Accounting and Finance
2009 McGraw-Hill Ryerson Limited

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Costs Terms, Concepts and Classifications

Chapter Two

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Learning Objective 1

Identify and give examples of each of the three basic cost elements involved in the manufacture of a product.

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Manufacturing Costs

Direct Direct Materials Materials

Direct Direct Labour Labour

Manufacturing Manufacturing Overhead Overhead

The Product

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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 Example: A radio installed in an automobile

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Direct Labour

Those labour costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workers 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 labour and indirect materials Examples: Indirect labour and indirect 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.

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Classifications of Costs
Manufacturing costs are often classified as follows:

Direct Direct Material Material

Direct Direct Labour Labour

Manufacturing Manufacturing Overhead Overhead

Prime Cost

Conversion Cost

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Non-manufacturing Costs

Selling Costs

Administrative Costs

Costs necessary to get the order and deliver the product.

All executive, organizational, and clerical costs.

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Learning Objective 2

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

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Product Costs Versus Period Costs

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

Period costs include all selling costs and administrative costs.

Expense

Balance Sheet
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Income Statement

Income Statement

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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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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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Comparing Merchandising and Manufacturing Activities

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

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

MegaLoMart

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Balance Sheet
Merchandiser Manufacturer
Current Assets
x Cash x Receivables x Prepaid Expenses x Inventories Raw Materials Work in Process Finished Goods

Current assets
Cash Receivables Prepaid Expenses Merchandise

Inventory

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

Current assets
Cash Receivables Prepaid Expenses

Partially complete Merchandise products Inventory some

material, labour, or overhead has been added.

Completed products awaiting sale.

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Learning Objective 3

Prepare an income statement including calculation of the cost of goods sold.

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The Income Statement

Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.
Merchandising Company
Cost of goods sold: Beg. merchandise inventory + Purchases Goods available for sale - Ending merchandise inventory = Cost of goods sold

$ 14,200 234,150 $ 248,350

(12,100) $ 236,250

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Class try Exercise 2-3, p. 53

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Learning Objective 4

Prepare a schedule of cost of goods manufactured.

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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.
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Product Cost Flows

Manufacturing Costs
Direct materials

Raw Materials
Beginning raw materials inventory Raw materials purchased Raw materials available for use in production Ending raw materials inventory Raw materials used in production

Work In Process

+ =

As items are removed from raw materials inventory and placed into the production process, they are called direct materials.

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Product Cost Flows

Manufacturing Costs

Raw Materials
Beginning raw materials inventory Raw materials purchased Raw materials available for use in production Ending raw materials inventory Raw materials used in production + + =

+ =

Conversion Direct materials costs are costs Direct labour incurred to Mfg. overhead convert the Total manufacturing direct material costs into a finished product.

Work In Proces

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Product Cost Flows

Manufacturing Costs
Direct materials + Direct labour + Mfg. overhead = Total manufacturing costs

Raw Materials
Beginning raw materials inventory Raw materials purchased Raw materials available for use in production Ending raw materials inventory Raw materials used in production

Work In Proces

+ =

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

Beginning work process inve + Total manufactu costs = Total work in process for t period costs incurred

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Product Cost Flows

Manufacturing Costs

Raw Materials

Work In Proces

Beginning raw Direct materials materials inventory + Direct labour + Raw materials + Mfg. overhead purchased = Total manufacturing = Raw materials costs available for use in production Costs associated with the goods that Ending raw materials are completed during the period are inventory = Raw materials used finished goods transferred to in production inventory.
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+ =

Beginning work process inve Total manufactu costs Total work in process for t period Ending work in process inve Cost of goods manufacture

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Product Cost Flows

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Manufacturing Cost Flows

Balance Sheet Inventories
Raw Materials Work in Process Finished Goods Cost of Goods Sold Selling and Administrative

Costs
Material Purchases Direct Labour Manufacturing Overhead

Income Statement Expenses

Selling and Administrative

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Period Costs

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Class try Exercise 2-4, p. 53

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Learning Objective 5

Explain the difference in the behaviour of variable and fixed costs.

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Cost Classifications for Predicting Cost Behaviour

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How a cost will react to How a cost will react to changes in the level of changes in the level of activity within the activity within the relevant range. relevant range.
Total variable costs Total variable costs change when activity change when activity changes. changes. Total fixed costs remain Total fixed costs remain unchanged when activity unchanged when activity changes. changes.

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Variable Cost

Your total long distance telephone bill is based on how many minutes you talk.
Total Long Distance Telephone Bill
Minutes Talked
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Fixed Cost
Your monthly basic telephone bill probably does not change when you make more local calls.
Monthly Basic Telephone Bill
Number of Local Calls

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Cost Classifications for Predicting Cost Behaviour

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Behavior of Cost (within the relevant range)

Cost Variable In Total Total variable cost changes as activity level changes. Total fixed cost remains the same even when the activity level changes. Per Unit Variable cost per unit remains the same over wide ranges of activity. Average 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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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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Learning Objective 6

Distinguish between direct and indirect costs.

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Assigning Costs to Cost Objects

Indirect costs
Costs that cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead

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

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Learning Objective 7

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

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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. 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.

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Class try Exercise 2-10, p. 55

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End of Chapter 2

2009 McGraw-Hill Ryerson Limited