2-1

Design Realization
(Design Calculation)
 2-2

Classifications of Manufacturing
Costs
Direct
Materials

Direct
Labor

Manufacturing
Overhead
 2-3

Direct Materials
Raw materials that become an integral
part of the product and that can be
conveniently traced directly to it.
 2-4

Direct Labor

Those labor costs that can be easily traced

to individual units of product.
 2-5

Manufacturing Overhead
Manufacturing costs that cannot be easily
traced directly to specific units produced.

Examples: Indirect materials and indirect labor

Materials used to support Wages paid to employees

the production process. who are not directly
Examples: chemicals and involved in production
cleaning supplies work. Examples: clean-up
workers, janitors, and
security guards.
 2-6

Classification of
Nonmanufacturing Costs
Selling Administrative
Costs Costs

Costs necessary to All executive,

secure the order and organizational, and
deliver the product. clerical costs.
 2-7

Product Costs Versus Period Costs

Product costs include Period costs include all
direct materials, direct selling costs and
labor, and manufacturing administrative costs.
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 2-8

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.
 2-9

Classifications of Costs
Manufacturing costs are often
classified as follows:

Direct Direct Manufacturing

Material Labor Overhead

Prime Conversion
Cost Cost
 2-10

Cost Classifications for

Predicting Cost Behavior
Cost behavior refers to
how a cost will react to
changes in the level of
activity. The most
common classifications
are:
▫Variable costs.
▫Fixed costs
▫Mixed costs.
 2-11

Variable Cost
A cost that varies, in total, in direct proportion to changes in
the level of activity. In some cases your total texting bill is
based on how many texts you send.
Total Texting Bill

Number of Texts Sent

 2-12

Variable Cost Per Unit

However, variable cost per unit is constant. In some cases the
cost per text sent is constant at constant cost per text.

Cost Per Text Sent

Number of Texts Sent

 2-13

The Activity Base (Cost Driver)

Units Machine
produced hours

A measure of what
causes the incurrence
of a variable cost

Miles Labor
driven hours
 2-14

Fixed Cost
A cost that remains constant, in total, regardless of
changes in the level of the activity. However, if
expressed on a per unit basis, the average fixed cost
per unit varies inversely with changes in activity.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

Within Monthly Plan
 2-15

Fixed Cost Per Unit

However, if expressed on a per unit basis, the average
fixed cost per unit varies inversely with changes in
activity.

Monthly Cell Phone Contract

Fee

Number of Minutes Used

Within Monthly Plan
 2-16

Types of Fixed Costs

Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced in the short-term by current
short term. managerial decisions

Examples Examples
Depreciation on Buildings Advertising and Research
and Equipment and Real and Development
Estate Taxes
 2-17

Mixed Costs
(also called semivariable costs)
A mixed cost contains both variable and fixed elements.
Consider the example of utility cost.
Y
Total Utility Cost

Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 2-18

Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX

Where: Y = The total mixed cost.

a = The total fixed cost (the
Y
vertical intercept of the line).
b = The variable cost per unit of
Total Utility Cost

activity (the slope of the line).

X = The level of activity.

Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 2-19

Mixed Costs – An Example

If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what
is the amount of your utility bill?

Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
 2-20

Analysis of Mixed Costs

Account Analysis and the Engineering Approach

In account analysis, each account is

classified as either variable or fixed based
on the analyst’s knowledge of how
the account behaves.

The engineering approach classifies costs

based upon an industrial engineer’s
evaluation of production methods, and
material, labor, and overhead requirements.
2-21