26.02.

2024

19&26 Cost Concepts

Examples of Types and

Uses of Operating Cost Information

Type of Organization
Manufacturing Retail Service

Cost information Cost to Cost to Cost to

needed by management manufacture purchase provide
the product the product the service
Uses of cost information:
To measure historical or
future profits Yes Yes Yes

To decide the selling price

for regular or special sales
or services provided Yes Yes Yes

To value finished goods or

merchandise inventories Yes Yes N/A
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Cost Information

• A single cost can be classified as

– Direct or indirect, depending on its traceability.
– Variable or fixed, depending on its behavior.
– Value-adding or nonvalue-adding, depending on
whether it adds value to a product or service.
– Product or period, depending on whether it is
inventoriable.

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Overview of Cost Classification

Cost Classifications and Their Uses

Common Cost Classifications:

Classification Breakdown Purpose

Traceability Direct Control costs by tracing
Indirect costs to a cost object

Behavior Variable Calculate number of units

that must be sold to obtain a
certain profit.
Fixed

Activity Based Value adding Identify the costs that add

value to the consumer.
Non-value adding

Financial Reporting Product Classify costs for the

preparation of financial
statements.
Period
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Value-Adding Versus Non-Value Adding Costs

Value Adding Cost – increases the market value of a product or service.
Non-Value Adding Cost – adds cost to a product or service but does not
increase its market value.

Costs for Financial Reporting

Product (Inventoriable) Costs – costs such as direct materials, direct
labor, and manufacturing overhead, that are assigned to inventory as
an asset, until sold.

[Product Costs may be Prime Costs (Direct Materials and Direct

Labor) or Conversion Costs (Direct Labor and Manufacturing
Overhead)].

Period (Non-inventoriable) Costs – costs of resources consumed, expensed as

incurred, during the accounting period and not assigned to products.
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Elements of Product Costs

1. Direct materials can be conveniently and economically

traced to specific units of product.
2. Direct labor can be conveniently and economically
traced to specific units of product.
3. Manufacturing overhead includes all manufacturing
costs that are not direct materials or direct labor costs.
Also called factory overhead or indirect manufacturing
costs.

Manufacturing Overhead

The following are examples of manufacturing overhead:

Indirect materials.
Indirect labor.
Depreciation associated with manufacturing operations.
Machinery and tool maintenance, taxes, insurance, rent, and
utilities relating to manufacturing.

Examples of Cost Classifications for a

Candy Manufacturer

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Relationships Among Product Costs

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Product Unit Cost

The manufacturing cost of a single unit of

product.

= COGM
Number of Units Produced

Or

= Sum of Costs per Unit for each Element

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Figure 2: Financial Statements of Service, Retail,

and Manufacturing Organizations

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Costing Methods

Three costing methods

• Actual costing
• Normal costing
• Standard costing

Actual Costing Method

The actual costing method uses the actual

cost information from the job to calculate
the unit cost of a product.
At the end of an accounting period, or
At the end of a job.

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Normal Costing Method

The normal costing method combines the

actual direct materials and direct labor costs
with the estimated manufacturing overhead
costs to determine product costs.
Actual DM, Actual DL, Estimated OH
Used when total actual overhead costs
are not known until the end of the year.
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Standard Costing Method

Estimated DM, Estimated DL, Estimated MOH

The standard costing method uses estimated product
cost information that is used:
As a benchmark or target for evaluating subsequent
performance.
For budgeting purposes.
For bidding on a future job.
For controlling product costs.
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Summary of the Use of Actual

or Estimated Costs in
Three Cost-Measurement Methods

Product Cost Actual Normal Standard

Elements Costing Costing Costing

Direct Actual Actual Estimated

materials costs costs costs

Direct labor Actual Actual Estimated

costs costs costs

Manufacturing Actual Estimated Estimated

overhead costs costs costs

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Cost Flows

Direct materials, labor, and overhead are

accumulated in the Work in Process Inventory
account.

When goods are completed the costs are

transferred to Finished Goods Inventory.

When the goods are sold, the costs are

transferred to Cost of Goods Sold.
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Manufacturing Cost Flow

Direct Materials Work in Process

Inventory Account Inventory Account

Balance 12/31/x3: Used during

Balance 12/31/x3: Completed
$10,000 20x4:
$ 2,000 during 20x4:
Total direct $25,000
$30,000
materials
Direct materials
purchased
used during 20x4:
during 20x4:
25,000
20,000
Direct labor 20x4:
12,000
Balance
Manufacturing
12/31/x4:
overhead 20x4:
$5,000
6,000

Balance 12/31/x4
$15,000
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Manufacturing Cost Flow

Work in Process
Inventory Account Finished Goods
Inventory Account
Balance 212/31/x3: Completed
$2,000 during 20x4: Balance 12/31/x3: Sold during 20x4:
$30,000 $6,000 $24,000
Direct materials
used during 20x4: Completed
25,000 during 20x4:
Direct labor 20x4: 30,000
12,000
Manufacturing
overhead 20x4: Balance
6,000 12/31/x4:
$12,000
Balance 12/31/x4
$15,000
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Cost of Goods Manufactured

• Cost of goods manufactured is a key component of the

income statement for a manufacturing company.
• Costs of Goods Manufactured Account (for a
manufacturing co.) replaces Purchases Account (for a
merchandising co.)
• Finished Goods Inventory replaces Merchandise
Inventory.

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Cost of Goods Manufactured

 Determining the cost of goods manufactured

involves three steps.
1. Computing the cost of materials used.
2. Computing direct labor and manufacturing
overhead.
3. Computing cost of goods manufactured, adjusting
for beginning and ending work in process.

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Cost of Goods Manufactured

The cost of goods manufactured is used

on the income statement to compute the
cost of goods sold.

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Statement of
Cost of Goods Manufactured: Step 1

Angelo’s Rolling Suitcases, Inc.

Statement of Cost of Goods Manufactured
For the Year Ended December 31, 2024

Direct Materials Used:

Direct Materials Inventory, 12/31/x3 $10,000
Direct Materials Purchased 20,000
Cost of Direct Materials Available for Use $30,000
Less Direct Materials Inventory, 12/31/x4 (5,000)
Cost of Direct Materials Used $25,000

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Statement of
Cost of Goods Manufactured: Step 2

Angelo’s Rolling Suitcases, Inc.

Statement of Cost of Goods Manufactured
For the Year Ended December 31, 2024

Cost of Direct Materials Used $25,000

Direct Labor 12,000
Manufacturing Overhead 6,000
Total Manufacturing Costs $43,000

Note: Total Manufacturing Costs Cost of Goods Manufactured

= Product Costs added during the
manufacturing period.

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Statement of
Cost of Goods Manufactured: Step 3

Angelo’s Rolling Suitcases, Inc.

Statement of Cost of Goods Manufactured
For the Year Ended December 31, 2024

Total Manufacturing Costs $43,000

Add Work in Process Inventory, 12/31/x3 2,000
Total Cost of Work in Process During the Year $45,000
Less Work in Process Inventory, 12/31/x4 (15,000)
Cost of Goods Manufactured $30,000

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Income Statement

Angelo’s Rolling Suitcases, Inc.

Income Statement
For the Year Ended December 31, 2024
Sales $50,000
Cost of Goods Sold:
Finished Goods Inventory, 12/31/23 $ 6,000
Cost of Goods Manufactured 30,000
Total Cost of Finished Goods
Available for Sale $36,000
Less Finished Goods Inventory,
12/31/24 (12,000)
Cost of Goods Sold (24,000)
Gross Margin $26,000
Selling & Administrative Expenses (16,000)
Net Income $10,000

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Example: Statement of Cost of Goods

Manufactured and Partial Income Statement for a
Manufacturing Organization

Exhibit 1: Statement of Cost of Goods

Manufactured and Partial Income Statement for a
Manufacturing Organization

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Predetermined Overhead Rate

The use of one predetermined overhead rate to
apply manufacturing overhead to a product is
appropriate if organizations:
1. Manufacture only one product, or
2. Manufacture a few very similar products that
require the same production processes and
production-related activities.

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Normal Costing Method

The normal costing method applies

manufacturing overhead costs to a
product’s cost by:
Estimating a predetermined
manufacturing overhead rate, and
Multiplying that rate by the actual level
of the cost driver consumed by that
product.
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Product Unit Cost

The total manufacturing overhead cost is

added to the actual costs of direct materials
and direct labor in order to determine the
total product cost.
The product unit cost is calculated by
dividing total product cost by total units
produced.

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Using the Traditional Approach to Assign Manufacturing

Overhead Costs to Production

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Assignment of Manufacturing Overhead

Costs:
Traditional Approach
Step 1: Calculate the
predetermined overhead rate.

Predetermined $200,000
Overhead Rate = 40,000 Direct
Labor Hours

$5 per Direct
= Labor Hour

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Assignment of Manufacturing Overhead Costs:

Traditional Approach

Step 2: Apply manufacturing

overhead costs to production.
Regular Rolling Suitcases

Cost Driver Level Cost Applied

Overhead costs applied:
Manufacturing overhead:
$5 per DLH X 25,000 DLH $125,000
Number of units  10,000
Manufacturing overhead $ 12.50
cost per unit

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Assignment of Manufacturing Overhead

Costs:
Traditional Approach
Step 2: Apply manufacturing
overhead costs to production.
Deluxe Rolling Suitcases

Cost Driver Level Cost Applied

Overhead costs applied:
Manufacturing overhead: X 15,000 DLH $ 75,000
$5 per DLH
Number of units  5,000
Manufacturing overhead $ 15.00
cost per unit

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Product Unit Cost:

Traditional Approach

Step 3: Product Unit Cost

Regular Deluxe
Rolling Suitcase Rolling Suitcase
Product costs per unit:
Direct materials (given) $40.00 $42.00
Direct labor (given) 37.50 45.00
Manufacturing overhead 12.50 15.00
Product unit cost $90.00 $102.00

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Service Organizations

A service organization does not have a

physical product that can be:
Assembled.
Stored.
Valued.

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Service Organizations

The most important cost in a service

organization is the professional labor cost (like
product cost in manufacturing.)
Service related overhead is the other principal
component of the cost of services rendered
(like manufacturing overhead.)

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Standard Costing System

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Standard Costing
A budgeting control technique with 3
components:
1. A standard, predetermined
performance level.
2. A measure of actual performance.
3. A measure of the variance, the
difference, between the standard and
the actual.

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Standard Costs

Standard costs are predetermined

costs that are developed from
analyses of both:
Past operating costs, quantities, and
times.
Future costs and operating
conditions.
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Standard Cost Flow

 In a standard costing system, standard costs for

direct materials, direct labor, and manufacturing
overhead flow through the inventory accounts
and eventually into the Cost of Goods Sold
account.
 The difference from normal costing systems is
that under standard costing systems, standard
costs instead of actual costs are used to record
all of these flows.
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The Management Cycle

Managers use standard costs throughout the

management cycle.
In the planning stage of the management
cycle, standard costs aid in the development
of budgets and as yardsticks for evaluating
capital expenditures.
During the executing stage, standard costs,
quantities, and times are applied to work
performed.
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The Management Cycle

 During the reviewing stage, actual costs are

compared with standard costs to compute
variances, and managers analyze the causes of
those variances to improve operations. Both
favorable and unfavorable variances should be
investigated.
 During the reporting stage, a variance report
provides information on operations and
managerial performance.
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Standard Costing, Variance Analysis, and

the Management Cycle

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Standard Costing Systems

The primary difference between a

standard costing system in service
versus manufacturing organizations is
that there are no direct materials
variances in service organizations.

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The Management Cycle

• In today’s globally competitive

environment, new standards or
measurements are necessary to help
managers:
– Reduce processing time.
– Improve quality.
– Improve customer satisfaction.
– Improve on-time deliveries.
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A Standard Costing System

Standard costs replace actual costs in

all accounts.
Materials Inventory, Work in Process,
Finished Goods and Cost of Goods
Sold balances are based on standard
costs.
Separate records are kept of actual
costs for comparison.

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Standard Cost per Unit

There are six standards used to determine

the standard cost per unit:
1. Direct materials price standard.
2. Direct materials quantity standard.
3. Direct labor time standard.
4. Direct labor rate standard.
5. Standard variable manufacturing overhead rate.
6. Standard fixed manufacturing overhead rate.

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Direct Materials Price Standard

The direct materials price standard

is calculated by carefully
considering:
Expected price changes.
Changes in available quantities.
Possible new sources of supply.

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Direct Materials Quantity Standard

u The direct materials quantity standard

is affected by:
4 Product engineering specifications.
4 Quality of direct materials.
4 Age and productivity of machines.
4 Quality and experience of the work force.

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Direct Labor Time Standard

The direct labor time standard is based

on:
Current time and motion studies of
workers and machines.
Past performance.

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Direct Labor Rate Standard

The direct labor rate standards are

affected by:
Labor union contracts.
Company personnel policies.

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Standard Direct Materials and Standard

Direct Labor Costs

Standard direct materials cost =

Direct materials price standard x
Direct materials quantity standard

Standard direct labor cost =

Direct labor time standard x
Direct labor rate standard

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Standard Manufacturing Overhead Costs

Standard manufacturing overhead cost =

(Standard variable overhead rate x
Variable overhead application basis)
+ (Standard fixed overhead rate x
Fixed overhead application basis)

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Standard Rates

Standard variable manufacturing overhead rate =

Total budgeted variable manufacturing overhead costs
÷ Expected number of standard machine hours

Standard fixed manufacturing overhead rate =

Total budgeted fixed manufacturing overhead costs
÷ Normal capacity in terms of standard machine hours

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Standard Unit Cost

• A product’s standard unit cost is

determined by adding:
– Standard direct materials cost.
– Standard direct labor cost.
– Standard manufacturing overhead cost.

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