Cost Terms, Concepts, and Classifications
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. LO3.Prepare an income statement 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. LO10.(Appendix 2B) Prepare and interpret a quality cost report.
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A.General Theme. Costs can be classified in a number of ways—depending on the purpose of the classification. For example, classification of costs for purposes of determining inventory valuations and cost of goods sold for external reports differs from the classification of costs that would be carried out to aid decision-making. It is important to note that the classifications of costs are not mutually exclusive. That is, a particular cost may be classified in many different ways—depending on the purpose of the classification.
B.Cost Classifications for Preparing External Financial Statements. (Exercises 2-1, 2-2, 2-3, 2-4, 2-10, 2-11, and 2-12.) This section of the chapter focuses on the problem of valuing inventories and determining cost of goods sold for external financial reports. Before beginning this discussion, you may want to explain the difference between a manufacturing and a merchandising company. Manufacturing companies convert raw materials into a product. The company then sells that product either to other companies or, less commonly, directly to individuals. “Manufacturing” includes restaurants, movie studios, and other service-type companies as well as the more obvious examples of manufacturing such as automobile and clothing production. Merchandising companies, by contrast, buy finished products and resell the products to customers. Valuing inventories and determining cost of goods sold is simple in a merchandising company, but is difficult in a manufacturing company. For that reason, we concentrate on manufacturing in this section of the chapter.
1.Manufacturing costs. These costs are incurred to make a product. Manufacturing costs are usually grouped into three main categories: direct materials, direct labor, and manufacturing overhead.
a.Direct materials. Direct materials consist of those raw material inputs that become an integral part of a finished product and can be easily traced into it. Examples include the aircraft engines on a Boeing 777, the Intel processing chip in a personal computer, and the blank video cassette in a pre-recorded video.
b.Direct Labor. Direct labor consists of that portion of labor cost that can be easily traced to a product. Direct labor is sometimes referred to as “touch labor” since it consists of the costs of workers who “touch” the product as it is being made.
c.Manufacturing Overhead. Manufacturing overhead consists of all manufacturing costs other than direct materials and direct labor. These costs cannot be easily and conveniently traced to products. Examples include miscellaneous supplies such as rivets in a Boeing 777, supervisors, janitors, factory facility charges, etc.
d.Prime versus Conversion Costs. Prime cost consists of direct...