Cost Concepts and Classifications

MANAGEMENT ACCOUNTING - Solutions Manual
CHAPTER 7
COST CONCEPTS AND CLASSIFICATIONS
I. Questions
1. The phrase different costs for different purposes refers to the fact that the word cost can
have different meanings depending on the context in which it is used. Cost data that are
classified and recorded in a particular way for one purpose may be inappropriate for another
use.
2. Fixed costs remain constant in total across changes in activity, whereas variable costs change in
proportion to the level of activity.
3. Examples of direct costs of the food and beverage department in a hotel include the money
spent on the food and beverages served, the wages of table service personnel, and the costs of
entertainment in the dining room and lounge. Examples of indirect costs of the food and
beverage department include allocations of the costs of advertising for the entire hotel, of the
costs of the grounds and maintenance department, and of the hotel general managers salary.
4. The cost of idle time is treated as manufacturing overhead because it is a normal cost of the
manufacturing operation that should be spread out among all of the manufactured products.
The alternative to this treatment would be to charge the cost of idle time to a particular job
that happens to be in process when the idle time occurs. Idle time often results from a random
event, such as a power outage. Charging the cost of the idle time resulting from such a
random event to only the job that happened to be in process at the time would overstate the
cost of that job.
5. a. Uncontrollable cost
b. Controllable cost
c. Uncontrollable cost
6. Product costs are costs that are associated with manufactured goods until the time period
during which the products are sold, when the product costs become expenses. Period costs
are expensed during the time period in which they are incurred.
7. The most important difference between a manufacturing firm and a service industry firm, with
regard to the classification of costs, is that the goods produced by a manufacturing firm are
inventoried, whereas the services produced by a service industry firm are consumed as they are
produced. Thus, the costs incurred in manufacturing products are treated as product costs
until the period during which the goods are sold. Most of the costs incurred in a service
industry firm to produce services are operating expenses that are treated as period costs.
8. Product costs are also called inventoriable costs because they are assigned to manufactured
goods that are inventoried until a later period, when the products are sold. The product costs
remain in the finished goods inventory account until the time period when the goods are sold.
8-1
Chapter 8 Cost Concepts and Classifications
9. A sunk cost is a cost that was incurred in the past and cannot be altered by any current or
future decision. A differential cost is the difference in a cost item under two decision
alternatives.
10.
b.
c.
d.
a. Direct cost
Direct cost
Indirect cost
Indirect cost
11.
The two properties of a relevant cost are:

1. it differs between the decision options
2. it will be incurred in the future
12.
The three types of product costs are:

1. direct materials the materials used in manufacturing the product, which become a
physical part of the finished product.
2. direct labor the labor used in manufacturing the product.
3. factory overhead the indirect costs for materials, labor, and facilities used to support the
manufacturing process, but not used directly in manufacturing the product.
13.
The three types of manufacturing inventories are:

1. materials inventory the store of materials used in the manufacturing process or in
providing the service.
2. work in process inventory accounts for all costs put into the manufacturing of products
that are started but not complete at the financial statement date.
3. finished goods inventory the cost of goods that are ready for sale.
14. Direct materials include the materials in the product and a reasonable allowance for scrap
and defective units, while indirect materials are materials used in manufacturing that are not
physically part of the finished product.
15. The income statement of a manufacturing company differs from the income statement of a
merchandising company in the cost of goods sold section. A merchandising company sells
finished goods that it has purchased from a supplier. These goods are listed as purchases in
the cost of goods sold section. Since a manufacturing company produces its goods rather than
buying them from a supplier, it lists cost of goods manufactured in place of purchases.
Also, the manufacturing company identifies its inventory in this section as Finished Goods
inventory, rather than as Merchandise Inventory.
16. Yes, costs such as salaries and depreciation can end up as part of assets on the balance
sheet if these are manufacturing costs. Manufacturing costs are inventoried until the associated
finished goods are sold. Thus, if some units are still in inventory, such costs may be part of
either Work in Process inventory or Finished Goods inventory at the end of a period.
8-2
Cost Concepts and Classifications Chapter 8
17. No. A variable cost is a cost that varies, in total, in direct proportion to changes in the level
of activity. A variable cost is constant per unit of product. A fixed cost is fixed in total, but the
average cost per unit changes with the level of activity.
18. Manufacturing overhead is an indirect cost since these costs cannot be easily and
conveniently traced to particular units of products.
19.
Direct labor cost (34 hours P15 per hour).................... P510
Manufacturing overhead cost (6 hours P15 per hour)..
90
Total wages earned.......................................................... P600
20.
Direct labor cost (45 hours P14 per hour)..................
Manufacturing overhead cost (5 hours P7 per hour). .
Total wages earned...........................
P630
35
P665
II. Exercises
Exercise 1 (Schedule of Cost of Goods Manufactured and Sold; Income Statement)
Requirement 1
Amazing Aluminum Company
Schedule of Cost of Goods Manufactured
For the Year Ended December 31, 2005
Direct material:
Raw-material inventory, January 1
P 60,000
Add: Purchases of raw material
250,000
Raw material available for use
P310,000
Deduct: Raw-material inventory, December

31
Raw material used
70,000
P240,000
Direct labor
400,000
Manufacturing overhead:
Indirect material
P 10,000
Indirect labor
25,000
Depreciation on plant and equipment
100,000
Utilities
25,000
8-3
...................................................................
...................................................................
Other
...................................................................
...................................................................
Total manufacturing overhead
30,000
190,000
Total manufacturing costs
P830,000
Add: Work-in-process inventory, January 1
120,000
Subtotal
.........................................................................
.........................................................................
Deduct: Work-in-process inventory, December 1
.........................................................................
Cost of goods manufactured
.........................................................................
P950,000
115,000
P835,000
Requirement 2
Schedule of Cost of Goods Sold
Finished goods inventory, January 1........................................
Add: Cost of goods manufactured...........................................
Cost of goods available for sale...............................................
Deduct: Finished goods inventory, December 31.....................
Cost of goods sold...................................................................
P150,000
835,000
P985,000
165,000
P820,000
Requirement 3
Income Statement
Sales revenue...........................................................................
Less: Cost of goods sold.........................................................
Gross margin...........................................................................
Selling and administrative expenses.........................................
Income before taxes.................................................................
Income tax expense..................................................................
Net income..............................................................................
P1,105,000
820,000
P 285,000
110,000
P 175,000
70,000
P 105,000
Exercise 2
Cost Item
a. Transportation-in costs on materials
purchased
Fixed (F)
Variable (V)
Period (P)
Product (R)
8-4
b. Assembly-line workers wages

c. Property taxes on work in process
inventories
d. Salaries of top executives in the
company
e. Overtime premium for assembly
workers
f. Sales commissions
g. Sales personnel office rental
h. Production supervisory salaries
i. Controllers office supplies
Cost Item
j. Executive office heat and air
conditioning
k. Executive office security personnel
l. Supplies used in assembly work
m. Factory heat and air conditioning
n. Power to operate factory equipment
o. Depreciation on furniture for sales
staff
p. Varnish used for finishing product
q. Marketing personnel health insurance
r. Packaging materials for finished
product
s. Salary of the quality control manager
who checks work on the assembly line
t. Assembly-line workers dental
insurance
V
F
R
P
V
F
F
F
Fixed (F)
Variable (V)
F
P
P
R
P
Period (P)
Product (R)
P
F
V
F
V
F
P
R
R
R
P
V
F
V
R
P
R
F
F
R
R
Exercise 3 (Cost Classifications; Manufacturer)

1.
2.
3.
4.
5.
6.
7.
8.
9.
a, d, g, i
a, d, g, j
b, f
b, d, g, k
a, d, g, k
a, d, g, j
b, c, f
b, d, g, k
b, c and d*, e and f and g*, k*
* The building is used for several purposes.
10.
11.
12.
13.
b, c, f
b, c, h
b, c, f
b, c, e
8-5
14.
15.
b, c and d, e and f and g, k

The building that the furnace heats is used for several purposes.
b, d, g, k
Exercise 4 (Economic Characteristics of Costs)

1.
2.
3.
4.
5.
6.
marginal cost
sunk cost
average cost
opportunity cost
differential cost
out-of-pocket cost
Exercise 5 (Cost Classifications; Hotel)

1.
2.
3.
4.
5.
6.
7.
8.
a, c, e, k
b, d, e, k
d, e, i
d, e, i
a, d, e, k
a, d, e, k
d, e, k
b, d, e, k
9. h
10.
Unless the dishwasher has been used improperly.
a, d, e*, j
* The hotel general manager may have some control over the total space allocated to the kitchen.
11.
12.
13.
14.
i
j
a, c, e
e, k
Exercise 6
Pickup Truck Output
8-6
3,000 trucks
6,000 trucks
9,000 trucks
Variable production costs P 29,640,000 P 59,280,000 P 88,920,000
Fixed production costs
39,200,000
39,200,000
39,200,000
Variable selling costs
4,500,000
9,000,000
13,500,000
Fixed selling costs
13,660,000
13,660,000
13,660,000
Total costs
P 87,000,000 P121,140,000 P155,280,000
Selling price per truck
46,000
40,100
35,900
Unit cost
29,000
20,190
17,253
Profit per truck
17,000
19,910
18,647
Exercise 7
(see next page)
Exercise 8
1.
2.
3.
4.
5.
The wages of employees who build the sailboats: direct labor cost.
The cost of advertising in the local newspapers: marketing and selling cost.
The cost of an aluminum mast installed in a sailboat: direct materials cost.
The wages of the assembly shops supervisor: manufacturing overhead cost.
Rent on the boathouse: a combination of manufacturing overhead, administrative, and
marketing and selling cost. The rent would most likely be prorated on the basis of the amount
of space occupied by manufacturing, administrative, and marketing operations.
6. The wages of the companys bookkeeper: administrative cost.
7. Sales commissions paid to the companys salespeople: marketing and selling cost.
8. Depreciation on power tools: manufacturing overhead cost.
8-7
Exercise 7
Variable
Cost
1. Wood used in a
table (P200 per
table)
2. Labor cost to
assemble a
table (P80 per
table)
3. Salary of the
factory
supervisor
(P76,000 per
year)
4. Cost of
electricity to
produce tables
(P4 per
machine-hour)
5. Depreciation of
machines used
to produce
tables (P20,000
per year)
6. Salary of the
company
president
(P200,000 per
year)
7. Advertising
expense
(P500,000 per
year)
8. Commissions
paid to
salespersons
(P60 per table
sold)
9. Rental income
forgone on
factory space
Period
Product Cost
Fixed
(Selling and
Direct Materials Direct Labor
Cost Administrative)
Cost
Sunk Cost
Opportunity
Cost
Manufacturing
Overhead
X*
X1
8-8
Exercise 9
Cost
The salary of the head chef
The salary of the head chef
Room cleaning supplies
Flowers for the reception desk
The wages of the doorman
Room cleaning supplies
Fire insurance on the hotel building
Towels used in the gym
1.
2.
3.
4.
5.
6.
7.
8.
Cost Object
The hotels restaurant
A particular restaurant customer
A particular hotel guest
The housecleaning department
The hotels gym
The hotels gym
Direct
Cost
X
Indirect
Cost
X
X
X
X
X
X
X
Note: The room cleaning supplies would most likely be considered an indirect cost of a particular
hotel guest because it would not be practical to keep track of exactly how much of each cleaning
supply was used in the guests room.
III.
Problems
Problem 1
The relevant costs for this decision are the differential costs. These are:
Opportunity cost or lost wages (take home)
[P1,500 x 70% x 12 months].. . P12,600
Tuition................................................
2,200
Books and supplies.............................
300
Total differential costs.................. P15,100
Room and board, clothing, car, and incidentals are not relevant because these are presumed to be the
same whether or not Francis goes to school. The possibility of part-time work, summer jobs, or
scholarship assistance could be considered as reductions to the cost of school. If students are
familiar with the time value of money, then they should recognize that the analysis calls for a
comparison of the present value of the differential after-tax cash inflows with the present value of
differential costs of getting the education (including the opportunity costs of lost income).
Problem 2
8-9
Requirement (a)
Only the differential outlay costs need be considered. The travel and other variable expenses of P22
per hour would be the relevant costs. Any amount received in excess would be a differential,
positive return to Pat.
Requirement (b)
The opportunity cost of the hours given up would be considered in this situation. Unless Pat receives
more than the P100 normal consulting rate, the contract would not be beneficial.
Requirement (c)
In this situation Pat would have to consider the present value of the contract and compare that to the
present value of the existing consulting business. The final rate may be more or less than the
normal P100 rate depending on the outcome of Pats analysis.
Problem 3
Utilities for the bakery
Paper used in packaging product
Salaries and wages in the bakery
Cookie ingredients
Bakery labor and fringe benefits
Bakery equipment maintenance
Depreciation of bakery plant and equipment
Uniforms
Insurance for the bakery
Boxes, bags, and cups used in the bakery
Bakery overtime premiums
Bakery idle time
Total product costs in pesos
2,100
90
19,500
35,000
1,300
800
2,000
400
900
1,100
2,600
500
66,290
8-10
Problem 4
Administrative costs
Rent for administration offices
Advertising
Office managers salary
Total period costs in pesos
1,000
17,200
1,900
13,000
33,100
Problem 5
Requirement (a)
Sunk costs not shown could include lost book value on traded assets, depreciation estimates for new
investment, and interest costs on capital needed during facilities construction.
Requirement (b)
The client might be used to differential cost as a decision tool, and believes (correctly) that use of
differential analyses has several advantages --- it is quicker, requires less data, and tends to give a
better focus to the decision. The banker might suspect the client of hiding some material data in
order to make the proposal more acceptable to the financing agency.
Problem 6
Requirement (1)
EH Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials, inventory, January 1
Add: Purchases of raw materials
Raw materials available for use
Deduct: Raw materials inventory,
December 31
Raw materials used in production
Direct labor
P 45,000
375,000
420,000
30,000
P 390,000
75,000
8-11
Manufacturing overhead:
Utilities, factory
Depreciation, factory
Insurance, factory
Supplies, factory
Indirect labor
Maintenance, factory
Total manufacturing overhead cost
Total manufacturing cost
Add: Work in process inventory, January
1
18,000
81,000
20,000
7,500
150,000
43,500
320,000
785,000
90,000
875,000
Deduct: Work in process inventory,

December 31
Cost of goods manufactured
50,000
P825,000
Requirement (2)
The cost of goods sold would be computed as follows:
Finished goods inventory, January 1
Add: Cost of goods manufactured
Goods available for sale
Deduct: Finished goods inventory, December
31
Cost of goods sold
P130,000
825,000
955,000
105,000
P850,000
Requirement (3)
EH Corporation
Income Statement
For the Year Ended December 31
Sales
Cost of goods sold (above)
Gross margin
Selling and administrative expenses:
Selling expenses
Administrative expenses
P1,250,000
850,000
400,000
P 70,000
135,000
8-12
205,000
Net operating income
P 195,000
8-13
Problem 7
Note to the Instructor: Some of the answers below are debatable.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
Cost Item
Depreciation, executive jet
Costs of shipping finished goods
to customers
Wood used in manufacturing
furniture
Sales managers salary
Electricity used in manufacturing
furniture
Secretary to the company
president
Aerosol attachment placed on a
spray can produced by the
company
Billing costs
Packing supplies for shipping
products overseas
Sand used in manufacturing
concrete
Supervisors salary, factory
Executive life insurance
Sales commissions
Fringe benefits, assembly line
workers
Advertising costs
Property taxes on finished goods
warehouses
Lubricants for production
equipment
*Could be an administrative cost.

**Could be an indirect cost.
Variable
or Fixed
F
V
V
F
Selling
Cost
Adminis-trative
Cost
X
Manufacturing
(Product) Cost
Direct
Indirect
X
X
X
V
V
X*
V
F
F
V
X
X
X
X
X**
V
F
Problem 8
Requirement (1)
Name of the Cost

Lings present salary
of P400,000 per
month
Rent on the garage,
P15,000 per month
Rent of production
equipment,
P50,000 per month
Materials for
producing
flyswatters, at
P30.00 each
Labor cost of
producing
flyswatters, at
P50.00 each
Rent of room for a
sales office, P7,500
per month
Answering device
attachment, P2,000
per month
Interest lost on
savings account,
P100,000 per year
Advertising cost,
P40,000 per month
Sales commission, at
P10.00 per
flyswatter
Legal and filing
fees, P60,000
Variable Fixed Direct

Cost
Cost Material
s
Product Cost
Direct
Mfg.
Admin.)
Labor
Overhead
Cost
Period
(Selling
and
Opportunity Sunk
Cost
Cost
X
X
X
X
X
X
X
X
8-15
Requirement (2)
The P60,000 legal and filing fees are not a differential cost. These legal and filing fees have already
been paid and are a sunk cost. Thus, the cost will not differ depending on whether Ling decides to
produce flyswatters or to stay with the consulting firm. All other costs listed above are differential
costs since they will be incurred only if Ling leaves the consulting firm and produces the
flyswatters.
Problem 9
Requirement (1)
Ms. Rios first action was to direct that discretionary expenditures be delayed until the first of the
new year. Providing that these discretionary expenditures can be delayed without hampering
operations, this is a good business decision. By delaying expenditures, the company can keep its
cash a bit longer and thereby earn a bit more interest. There is nothing unethical about such an
action. The second action was to ask that the order for the parts be cancelled. Since the clerks
order was a mistake, there is nothing unethical about this action either.
The third action was to ask the accounting department to delay recognition of the delivery until
the bill is paid in January. This action is dubious. Asking the accounting department to ignore
transactions strikes at the heart of the integrity of the accounting system. If the accounting system
cannot be trusted, it is very difficult to run a business or obtain funds from outsiders. However, in
Ms. Rios defense, the purchase of the raw materials really shouldnt be recorded as an expense.
He has been placed in an extremely awkward position because the companys accounting policy is
flawed.
Requirement (2)
The companys accounting policy with respect to raw materials is incorrect. Raw materials should
be recorded as an asset when delivered rather than as an expense. If the correct accounting policy
were followed, there would be no reason for Ms. Rio to ask the accounting department to delay
recognition of the delivery of the raw materials. This flawed accounting policy creates incentives
for managers to delay deliveries of raw materials until after the end of the fiscal year. This could
lead to raw materials shortages and poor relations with suppliers who would like to record their
sales before the end of the year.
The companys manage-by-the-numbers approach does not foster ethical behaviorparticularly
when managers are told to do anything so long as you hit the target profits for the year. Such
8-16
no excuses pressure from the top too often leads to unethical behavior when managers have
difficulty meeting target profits.
IV.
Multiple Choice Questions

1.
2.
3.
4.
5.
6.
B
D
B
A
C
D
7. C
8. D
9. C
10. C
11. A
12. C
13. D
14. D
15. B
16. A
17. C
18. C
19.
20.
21.
22.
23.
24.
A
A*
B
B
C
C
25.
26.
27.
28.
29.
30.
C
B
B
A **
A
B
* Controllable costs are those costs that can be influenced by a specified manager within a given
time period.
** The answer assumes absorption costing method is used.
Supporting Computations
14.
P60 + P10 + P18 + P4 = P92 16. P60 + P10 + P18 + P32 =
P120
15.
P32 + P16 = P48 17. P4 + P16 = P20
8-17

Cost Concepts and Classifications

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MANAGEMENT ACCOUNTING - Solutions Manual

Chapter 8 Cost Concepts and Classifications

The two properties of a relevant cost are:

The three types of product costs are:

The three types of manufacturing inventories are: