Cost Accounting

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Chapter

2
Learning Objectives
After studying Chapter 2, you should be able to:

LO1 Identify and give examples of each
of the three basic manufacturing cost
categories.
LO2 Distinguish between product costs
and period costs and give examples of
each.
including calculation of the cost of
goods sold.

LO4 Prepare a schedule of cost of
goods manufactured.
LO5 Understand the differences
between variable costs and fixed costs.
LO6 Understand the differences
between direct and indirect costs.
LO7 Define and give examples of cost
classifications used in making decisions:
differential costs, opportunity costs, and
sunk costs.
LO8 (Appendix 2A) Properly account
for labor costs associated with idle time,
overtime, and fringe benefits.
LO9 (Appendix 2B) Identify the four
types of quality costs and explain how
they interact.

Costs Add Up
Understanding costs and how
they behave is critical in business. Labor Ready is a company based in Tacoma, Washington,
that fills temporary manual labor jobs throughout the United States, Canada, and the UK—
issuing over 6 million paychecks
each year to more than half a
million laborers. For example,
food vendors at the Seattle
Mariners’ Safeco Field hire Labor Ready workers to serve soft drinks and food at baseball games. Employers are charged about $11 per hour for this service. Since Labor Ready pays its workers only about $6.50 per hour and offers no fringe benefits and has no national competitors, this business would appear to be a gold mine generating about $4.50 per hour in profit. However, the company must maintain 687 hiring offices, each employing a permanent staff of four to five persons. Those costs, together with payroll taxes, workmen’s compensation insurance, and other administrative costs, result in a margin of only about 5%, or a little over 50¢ per hour. ■

BU SI N E SS FOC U S

LO3 Prepare an income statement

Cost Terms, Concepts,
and Classifications

Source: Catie Golding, “Short-Term Work, Long-Term Profits,” Washington CEO, January 2000, pp. 10–12.

LO10

(Appendix 2B) Prepare and
interpret a quality cost report.

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Cost Terms, Concepts, and Classifications

39

s explained in Chapter 1, the work of management focuses on (1) plan-

Suggested Reading
For an interesting perspective on
the historical development of cost
and management accounting,
refer to H. Thomas Johnson, “The
Decline of Cost Management: A
Reinterpretation of 20th-Century
Cost Accounting History,” Journal
of Cost Management, Spring
1987, pp. 5–12; and H. Thomas
Johnson and Robert S. Kaplan,
“The Rise and Fall of Management Accounting,” Management Accounting, January 1987,
pp. 22–30.

A

ning, which includes setting objectives and outlining how to attain these objectives; and (2) control, which includes the steps taken to ensure that objectives are realized. To carry out these planning and control responsibilities, managers need information about the organization. This information often relates to the costs of the organization. In managerial accounting, the term cost is used in many different ways. The reason is that there are many types of costs, and these costs are classified differently according to the immediate needs of management. For example, managers may want cost data to prepare external financial reports, to prepare planning budgets, or to make decisions. Each different use of cost data demands a different classification and definition of costs. For example, the preparation of external financial reports requires the use of historical cost data, whereas decision making may require predictions about future costs.

In this chapter, we discuss many of the possible uses of cost data and how costs are defined and classified for each use. Our first task is to explain how costs are classified for the purpose of preparing external financial...
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