ACCOUNTANCY 2203

REVIEW WORKSHOP
SINDHU BALA

OVERVIEW OF COST CATEGORIES

FOR A MANUFACTURING FIRM

All costs incurred by the firm must be accounted for in

its financial statements
MANUFACTURING COSTS
Direct Labor (DL)
Direct Materials (DM)
Overhead (OH)
Indirect Materials
Indirect Labor
Other
NON-MANUFACTURING COSTS
Marketing or Selling Costs
Administrative Costs

MANUFACTURING COSTS
1. Direct Materials (DM)

Materials that are consumed in the manufacturing

process and physically incorporated in the finished
product

Materials whose cost is sufficiently large to justify the

record keeping expenses necessary to trace the costs to
individual products

MANUFACTURING COSTS
2. Direct Labor (DL)

Labor time that is physically traceable to the

products being manufactured

Labor time whose cost is sufficiently large to

justify the record keeping expenses necessary to
trace the costs to individual products
Example:
Direct labor for manufacturing Honda Accords

Line workers, robot operators, painters, assembly

workers
Any labor probably not included in direct labor?

Factory janitors, factory supervisors, factory

secretaries

KEY ISSUES IN DETERMINING

DIRECT LABOR
Is idle time generally considered as direct labor? Why
or why not?
Usually not. It is not usually due to one product,
hence it is not traceable
What are the typical fringe benefits an assembly line
worker receives?
Health insurance, pension plan, disability insurance
Is the cost of fringe benefits for the assembly line
workers generally considered direct labor?
Usually yes, the costs can be traced

KEY ISSUES IN DETERMINING

DIRECT LABOR
When an assembly line worker works overtime, he/she is
paid a regular wage plus an overtime premium. Would
most companies treat his/her regular wage as a direct
labor cost?
Yes, the amount of time an employee works can be traced
to the products.
What about the overtime premium?
Treated as OH, cannot be traced to a specific product.

MANUFACTURING COSTS
3. Manufacturing Overhead (OH)
All of costs of manufacturing excluding direct materials
and direct labor
a. Indirect Materials (IM) Materials, used in the
manufacturing of products, which are difficult to trace
to particular products in an economical way

Glue, nails, cleaning supplies

b. Indirect Labor (IL) Labor, used in the
manufacturing of products, which is difficult to trace to
particular products in an economical way

Wages for maintenance workers, factory supervisors

salary, idle time

MANUFACTURING COSTS
C. All other types of manufacturing overhead

Depreciation on machinery, depreciation on

factory building, factory insurance, utilities for
factory

NON-MANUFACTURING COSTS
1. Marketing or Selling Costs Costs incurred
in securing orders from customers and
providing customers with the finished product

Sales commissions, costs of shipping products

to customers, storage of finished goods,
depreciation of selling equipment (cash
register)
2. Administrative Costs Executive,
organizational, and clerical costs that are not
related to manufacturing or marketing

CEOs salary, cost of controllers office,

depreciation on administrative building.

CLASSIFICATION
EXERCISE
Classify the following cost items

Depreciation on factory building

Depreciation on office equipment
Property tax on finished goods
warehouse
Wages paid to forklift operator in
finished goods warehouse
Wages paid to forklift operator in factory
Wages paid to welders when welding
equipment is not working
Paper used in textbook production
Paper used in central office computer
Wages paid to assembly line workers
Maintenance cost for machines

OTHER COST CONCEPTS

Product Costs or Inventoriable Costs costs assigned
to products that were either purchased for resale
(merchandising firm or retailer) or manufactured for sale
(manufacturing firm)
When products are sold, product costs are recognized as
an expense (cost of goods sold or COGS). The costs of
unsold products remain in inventory and are not expensed
(i.e. not deducted from revenue in calculating net income)
Period Costs costs that are not product costs and that
are associated with the period in which they are incurred
Period costs such as selling and administrative costs are
expensed (i.e. deducted from revenue in calculating net
income) in the period they are incurred

PRODUCT COSTS VERSUS PERIOD

COSTS
Product costs include
direct materials, direct
labor, and
manufacturing
overhead.
Cost of
Goods Sold

Inventory

Period costs are not

included in product
costs. They are
expensed on the
income statement.
Expense

Sale

Balance
Sheet

Income
Statement

Income
Statement

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.

COSTS RELATED TO DECISION

MAKING
Opportunity Costs - costs when taking one action
requires giving up the opportunity to earn profits from a
different action

Nike Inc. has limited production capacity. What would

be Nikes opportunity cost of accepting a special order
from the military for combat boots?
If Nike accepts the special order, they may not be able to
produce enough product for other sales. So, Nike would
lose the profit from the other sale.

COSTS RELATED TO DECISION

MAKING
Incremental Costs or Differential Costs additional
costs incurred when choosing a certain course of action
over another (Note that incremental costs can include
opportunity costs)

What would be Macys incremental costs of expanding

its fragrance department and shrinking its accessories
department?
The costs of stocking and staffing the new fragrance
area, opportunity costs of lost profit from the decrease in
sales of accessories

COSTS RELATED TO DECISION

MAKING
Incremental Benefits or Differential Benefits additional
benefits reaped when choosing a certain course of action over
another
What would be Macys incremental benefits of expanding its
fragrance department and shrinking its accessories
department?
Profits Macys expects to earn on the new fragrances it
displays/stocks
Sunk Costs Costs that have been incurred and that are not
affected by any current/future action

What would be considered sunk cost if Macys decides to expand

its fragrance department and shrink its accessories
department?
Depreciation on the building, cost of the building

COST FLOWS IN A
MANUFACTURING COMPANY
3.

4.

Inputs such as labor and capital equipment are

also incurred to make the product. The costs of
all the inputs used in the manufacturing
facilities are recorded in WORK IN PROCESS
INVENTORY
As products are finished, they are moved to
finished goods warehouse and their costs are
recorded in FINISHED GOODS (FG)
INVENTORY

COST FLOWS IN A
MANUFACTURING COMPANY

THE INVENTORY EQUATION

QUICK CHECK
If your inventory balance at the beginning of the
month was $1,000, you bought $100 during the
month, and sold $300 during the month, what
would be the balance at the end of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.

$1,000 + $100 = $1,100

$1,100 - $300 = $800

QUICK CHECK
Beginning raw materials inventory was
$32,000. During the month, $276,000 of raw
material was purchased. A count at the end
of the month revealed that $28,000 of raw
material was still present. What is the cost of
direct material used?

A.
B.
C.
D.

$276,000
$272,000
$280,000
$ 2,000

QUICK CHECK
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?

A.
B.
C.
D.

$1,160,000
$ 910,000
$ 760,000
Cannot be determined.

VARIABLE AND FIXED

COSTS

Activity a quantitative measure of a firms output of goods or

services
Number of Chrysler vans
Pairs of Nike shoes
Tons of cement produced
Variable Costs costs that change proportionately (in total) with
the activity level within a relevant range of activity
Fixed Costs costs that do not change in total as activity level
changes within a relevant range of activity
Example: Publishing a magazine
Variable costs
Fixed Costs
Cost of paper
Rent on building
Cost of ink
Salaries to reporters
Sales Commissions
Depreciation on printing
equipment
Cost of lubricants for machine
Cost of operating press

TOTAL VARIABLE AND FIXED COSTS

Total Variable Cost

Total Fixed Cost

Number of units

Number of units

VARIABLE AND FIXED COSTS PER

UNIT
Per Unit Variable Cost

Per Unit Fixed Cost

Number of units

Number of units

RELEVANT RANGE
The range of activity within which the firms cost structure (i.e.
variable cost per unit and total fixed cost) remains unchanged

Publishing a small number of magazines (cost structure of a

small publisher)

Total Variable Cost

Relevant Range

Total Fixed Cost

Number of units

Relevant Range

Number of units

TOTAL COSTS
To get total costs you need to add variable costs and
fixed costs
Total Cost

Fixed costs

The Slope is the

variable cost per
unit
Number of units