1. Cost Concepts and Cost Allocation19

2. Cost Information
OBJECTIVE 1: Explain how managers classify costs and how they use these cost classifications.

3. Figure 1: Overview of Cost Classifications

4. Table 1: Examples of Cost Classifications for a Candy Manufacturer

5. Managers’ use of cost information
Different organizations have different operating costs
Service industries use the estimated costs of services
Retail organizations work with the estimated cost of merchandise
Manufacturing use estimated product costs

6. Cost Information
All organizations use cost information to determine profits and selling prices and to value inventory.

7. A single cost can be classified as
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.

8. Managers use cost classifications to
Cost Information
Managers use cost classifications to
Control costs by determining which are traceable to a particular cost object.
Calculate the number of units that must be sold to obtain a certain level of profit.

9. Managers use cost classifications to (cont.)
Cost Information
Managers use cost classifications to (cont.)
Identify the costs of activities that do and do not add value to a product or service.
Prepare financial statements.

11. Financial Statements and the Reporting of Costs
OBJECTIVE 2: Compare how service, retail, and manufacturing organizations report costs on their financial statements and how they account for inventories.

12. Figure 2: Financial Statements of Service, Retail, and Manufacturing Organizations

13. Exhibit 1: Statement of Cost of Goods Manufactured and Partial Income Statement for a Manufacturing Organization

14. Exhibit 1: Statement of Cost of Goods Manufactured and Partial Income Statement for a Manufacturing Organization

15. Financial Statements and the Reporting of Costs
A manufacturer maintains three inventory accounts on its balance sheet: Materials Inventory, Work in Process Inventory, and Finished Goods Inventory.
Because a service organization sells services rather than products, it maintains no inventory accounts.

16. Financial Statements and the Reporting of Costs
A manufacturer maintains three inventory accounts on its balance sheet: Materials Inventory, Work in Process Inventory, and Finished Goods Inventory. (cont.)
A retail organization, which purchases products ready for resale, maintains only a Merchandise Inventory account.

17. Financial Statements and the Reporting of Costs
Cost of goods manufactured is a key component of a manufacturing company’s income statement.
Determining the cost of goods manufactured involves three steps:
Computing the cost of direct materials used during the period
Computing total manufacturing costs for the period
Computing cost of goods manufactured, adjusting for beginning and ending work in process inventory

18. Financial Statements and the Reporting of Costs
The cost of goods manufactured is used on the income statement to compute the cost of goods sold.
Manufacturing, retail, and service organizations use the same income statement format.

20. Inventory Accounts in Manufacturing Organizations
OBJECTIVE 3: Describe the flow of costs through a manufacturer’s inventory accounts.

21. Figure 3: Activities, Documents, and Cost Flows Through the Inventory Accounts of a Manufacturing Organization

22. Figure 4: Manufacturing Cost Flow: An Example Using Actual Costing for The Choice Candy Company

23. Inventory Accounts in Manufacturing Organizations
Transforming materials into finished products ready for sale requires a number of production and production-related activities, including the following:
Purchasing, receiving, inspecting, storing, and moving materials
Converting materials into finished products using labor, equipment, and other resources
Moving, storing, and shipping the finished products

24. Inventory Accounts in Manufacturing Organizations
Manufacturing cost flow begins when costs are incurred for direct materials, direct labor, and overhead.
Materials costs flow first into the Materials Inventory account.
All manufacturing-related costs then flow into the Work in Process Inventory account.

25. Inventory Accounts in Manufacturing Organizations
Manufacturing cost flow begins when costs are incurred for direct materials, direct labor, and overhead.
When goods are completed, their costs are transferred to the Finished Goods Inventory account.
When goods are sold, their costs are transferred to the Cost of Goods Sold account.

26. Inventory Accounts in Manufacturing Organizations
Documents used to track the flow of manufacturing costs include the following:
Purchase request
Purchase order
Receiving report
Vendor’s invoice
Materials request form

27. Inventory Accounts in Manufacturing Organizations
Documents used to track the flow of manufacturing costs include the following: (cont.)
Time cards
Job order cost card
Sales invoice
Shipping document

29. Elements of Product Costs
OBJECTIVE 4: Define product unit cost, and compute the unit cost of a product or service.

30. Figure 5: Relationships Among Product Cost Classifications

31. Table 2: Use of Actual and Estimated Costs in Three Cost-Measurement Methods

32. Elements of Product Costs
The three elements of product cost are direct materials costs, direct labor costs, and overhead costs.
Direct materials costs can be conveniently and economically traced to specific units of a product.
Direct labor costs can be conveniently and economically traced to specific units of a product.

33. Elements of Product Costs
The three elements of product cost are direct materials costs, direct labor costs, and overhead costs. (cont.)
Overhead costs are all manufacturing costs not classified as direct materials or direct labor costs. They include the following:
Indirect materials costs
Indirect labor costs
The costs of property taxes, depreciation on plant and equipment, insurance, rent, and utilities

34. Elements of Product Costs
The three elements of manufacturing costs can be classified as prime costs or conversion costs.

35. Elements of Product Costs
A product’s unit cost equals the sum of direct materials, direct labor, and overhead costs divided by the number of units produced.
The actual costing method uses actual cost information available at the end of an accounting period or at the end of a job to calculate the unit cost of a product.

36. Elements of Product Costs
A product’s unit cost equals the sum of direct materials, direct labor, and overhead costs divided by the number of units produced. (cont.)
The normal costing method combines the actual direct materials and direct labor costs with estimated overhead costs to calculate product unit cost.

37. Elements of Product Costs
A product’s unit cost equals the sum of direct materials, direct labor, and overhead costs divided by the number of units produced. (cont.)
The standard costing method uses estimated costs of direct materials, direct labor, and overhead to calculate product unit cost.

38. Elements of Product Costs
A service business does not have a physical product that can be assembled, stored, and valued as inventory.
The most important cost in a service business is the professional labor cost.
Service-related overhead is the other principal component of the cost of services rendered.

40. Cost Allocation
OBJECTIVE 5: Define cost allocation and explain how the traditional method of allocating overhead costs figures into calculating product or service unit cost.

41. Figure 6: Allocating Overhead Costs: A Four-Step Process

42. Figure 6: Allocating Overhead Costs: A Four-Step Process

43. Table 3: Allocating Overhead Costs and Calculating Product Unit Cost: Traditional Approach

44. Cost Allocation
Cost allocation is the process of assigning a collection of indirect costs to a specific cost object using an allocation base known as a cost driver.
A cost object (the destination of an assigned indirect cost) is a product, process, department, or activity that the organization wishes to cost.

45. Cost Allocation
Cost allocation is the process of assigning a collection of indirect costs to a specific cost object using an allocation base known as a cost driver. (cont.)
A cost driver is a volume-related activity base, such as direct labor hours, direct labor costs, or units produced.

46. Cost Allocation
Cost allocation is the process of assigning a collection of indirect costs to a specific cost object using an allocation base known as a cost driver. (cont.)
As the cost driver increases in volume, it causes the cost pool—the collection of indirect costs assigned to a cost object—to increase in amount.

47. The allocation of overhead costs requires the following:
Cost Allocation
The allocation of overhead costs requires the following:
The pooling of overhead costs that are affected by a common activity
The selection of a cost driver whose activity level causes a change in the cost pool

48. The allocation of overhead costs requires the following: (cont.)
Cost Allocation
The allocation of overhead costs requires the following: (cont.)
Allocating overhead costs is a four-step process:
Managers estimate overhead costs and calculate a predetermined overhead rate (a single, plantwide rate in traditional settings) at which those costs will be assigned to products.
As units of the product or service are produced, the estimated overhead costs are assigned to the product or service’s costs at the predetermined rate.

49. The allocation of overhead costs requires the following: (cont.)
Cost Allocation
The allocation of overhead costs requires the following: (cont.)
Allocating overhead costs is a four-step process: (cont.)
Actual overhead costs are recorded as they are incurred.

50. The allocation of overhead costs requires the following: (cont.)
Cost Allocation
The allocation of overhead costs requires the following: (cont.)
Allocating overhead costs is a four-step process: (cont.)
At the end of the accounting period, the difference between the actual and applied overhead costs is calculated and reconciled.
If the difference is immaterial, the Cost of Goods Sold account is adjusted.
If the difference is material, adjustments are made to the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts.

51. The traditional approach to allocating overhead
Cost Allocation
The traditional approach to allocating overhead
The traditional approach to assigning overhead costs to a product or a service’s cost is to use a single (plantwide) predetermined overhead rate.
The total overhead costs constitute one cost pool.

52. The traditional approach to allocating overhead (cont.)
Cost Allocation
The traditional approach to allocating overhead (cont.)
The traditional approach is especially useful when a company manufactures only one product or a few very similar products that require the same production processes and production-related activities.

53. The traditional approach to allocating overhead (cont.)
Cost Allocation
The traditional approach to allocating overhead (cont.)
The traditional approach assigns overhead costs to a product’s cost by estimating a predetermined overhead rate and multiplying that rate by the actual level of the cost driver.

54. The traditional approach to allocating overhead (cont.)
Cost Allocation
The traditional approach to allocating overhead (cont.)
The total applied overhead cost is added to the actual costs of direct materials and direct labor to determine the total product or service cost.

55. The traditional approach to allocating overhead (cont.)
Cost Allocation
The traditional approach to allocating overhead (cont.)
The product or service unit cost is calculated by dividing total product or service cost by total units produced or by determining the cost per unit for each element of the product or service’s cost and summing those per-unit costs.

56. Cost Allocation
Activity-based costing (ABC) is a method of assigning costs that calculates a more accurate product or service cost than the traditional approach by categorizing all indirect costs by activity, tracing the indirect costs to those activities, and assigning activity costs to products or services using a cost driver related to the cause of the cost.