CHAPTER 8
COST CONCEPTS AND CLASSIFICATIONS
I. Questions1. 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 manager’s 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.
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. a. Direct cost b. Direct cost c. Indirect cost d. 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.
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 70,000
Raw material used 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
Other
... ...
Total manufacturing overhead 190,000 Total manufacturing costs... P830,000 Add: Work-in-process inventory, January 1... 120,000 Subtotal...
...
P950,000 Deduct: Work-in-process inventory,
December 1... 115,000 Cost of goods manufactured... P835,000
Requirement 2
Amazing Aluminum Company Schedule of Cost of Goods Sold For the Year Ended December 31, 2005
Finished goods inventory, January 1... P150,000 Add: Cost of goods manufactured... 835,000 Cost of goods available for sale... P985,000 Deduct: Finished goods inventory, December 31... 165,000 Cost of goods sold... P820,000
Requirement 3
Amazing Aluminum Company Income Statement
For the Year Ended December 31, 2005
Sales revenue... P1,105,000 Less: Cost of goods sold... 820,000 Gross margin... P 285,000 Selling and administrative expenses... 110,000 Income before taxes... P 175,000 Income tax expense... 70,000 Net income ... P 105,000 Exercise 2 Cost Item Fixed (F) Variable (V) Period (P) Product (R)
a. Transportation-in costs on materials
purchased V R
c. Property taxes on work in process
inventories V R
d. Salaries of top executives in the company F P
e. Overtime premium for assembly workers V R
f. Sales commissions V P
g. Sales personnel office rental F P
h. Production supervisory salaries F R
i. Controller’s office supplies F P
j. Executive office heat and air conditioning F P
k. Executive office security personnel F P
l. Supplies used in assembly work V R
m. Factory heat and air conditioning F R
n. Power to operate factory equipment V R
o. Depreciation on furniture for sales staff F P
p. Varnish used for finishing product V R
q. Marketing personnel health insurance F P
r. Packaging materials for finished product V R s. Salary of the quality control manager
who checks work on the assembly line F R
t. Assembly-line workers’ dental insurance F R Exercise 3 (Cost Classifications; Manufacturer)
1. a, d, g, i 2. a, d, g, j 3. b, f 4. b, d, g, k 5. a, d, g, k 6. a, d, g, j 7. b, c, f 8. b, d, g, k
9. b, c and d*, e and f and g*, k*
* The building is used for several purposes. 10. b, c, f
11. b, c, h 12. b, c, f 13. b, c, e
14. b, c and d†, e and f and g†, k†
15. b, d, g, k
Exercise 4 (Economic Characteristics of Costs) 1. marginal cost 2. sunk cost 3. average cost 4. opportunity cost 5. differential cost 6. out-of-pocket cost
Exercise 5 (Cost Classifications; Hotel) 1. a, c, e, k 2. b, d, e, k 3. d, e, i 4. d, e, i 5. a, d, e, k 6. a, d, e, k 7. d, e, k 8. b, d†, e, k
† Unless the dishwasher has been used improperly. 9. h
10. a, d, e*, j
* The hotel general manager may have some control over the total space
allocated to the kitchen.
11. i 12. j 13. a, c, e 14. e, k
Exercise 6
Pickup Truck Output
3,000 trucks 6,000 trucks 9,000 trucks
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
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
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.
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 Pat’s analysis.
Problem 3
Utilities for the bakery 2,100
Paper used in packaging product 90
Salaries and wages in the bakery 19,500
Cookie ingredients 35,000
Bakery labor and fringe benefits 1,300
Bakery equipment maintenance 800
Depreciation of bakery plant and equipment 2,000
Uniforms 400
Insurance for the bakery 900
Boxes, bags, and cups used in the bakery 1,100
Bakery overtime premiums 2,600
Bakery idle time 500
Total product costs in pesos 66,290
Problem 4
Administrative costs 1,000
Rent for administration offices 17,200
Advertising 1,900
Office manager’s salary 13,000
Total period costs in pesos 33,100
Problem 5
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.
IV. Multiple Choice Questions
1. B 7. C 13. D 19. A 25. C 2. D 8. D 14. D † 20. A * 26. B 3. B 9. C 15. B † 21. B 27. B 4. A 10. C 16. A † 22. B 28. A ** 5. C 11. A 17. C † 23. C 29. A 6. D 12. C 18. C 24. C 30. 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
