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 supervisor’s 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
 CEO’s salary, cost of controller’s 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 Period costs are not
direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Cost of
Inventory Goods Sold
Expense

Sale

Balance Income Income

Sheet Statement 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 Nike’s

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 Macy’s 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 Macy’s incremental benefits of expanding its fragrance
department and shrinking its accessories department?
Profits Macy’s 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 Macy’s 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. 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
4. 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
RAW MATERIALS INVENTORY
Beg. Bal. - RM Materials used in Production (DM)
Materials Purchased

End. Bal. - RM

WORK IN PROCESS INVENTORY

Beg. Bal. - WIP Cost of Goods Manufactured
DM (COGM)
DL
OH

End. Bal. - WIP

FINISHED GOODS INVENTORY

Beg. Bal. - FG Cost of Goods Sold (COGS)
COGM

End. Bal. - FG
THE INVENTORY EQUATION

Beginning Inventory Ending Inventory

+ = +
Additions to Inventory Items Removed from Inventory

 The inventory equation allows us to put together the following schedules:

Schedule of Total Manufacturing Costs Schedule of Cost of Goods Manufactured

(of the period)
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.
$1,000 + $100 = $1,100
C. $1,200. $1,100 - $300 = $800
D. $ 200.
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. $276,000
B. $272,000
C. $280,000
D. $ 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. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
VARIABLE AND FIXED COSTS
Activity – a quantitative measure of a firm’s 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 firm’s 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 Total Fixed Cost

Relevant Range 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