Basic Cost Management Concepts and Accounting for Mass Customization Operations

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Chapter Two

• Basic Cost Management Concepts and Accounting
  for Mass Customization Operations

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Process of Management
Managers need cost information toperform each of
these functions.
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What Do We Mean By a Cost?
A Costis the measure ofresources givenup to
achieve aparticular purpose.
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Manufacturing Costs
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Direct Material

Cost of raw material that is used tomake, and
can be convenientlytraced, to the finished
product.
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Direct Labor

Cost of salaries, wages, and fringebenefits for
personnel who workdirectly on manufactured
products.
Example Wages paid to anautomobile
assemblyworker.
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Manufacturing Overhead

• All other manufacturing costs

IndirectLabor
IndirectMaterial
OtherCosts
Materials used to support the production process.
Examples lubricants and cleaning supplies used
in an automobile assembly plant.
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Manufacturing Overhead

• All other manufacturing costs

IndirectLabor
IndirectMaterial
OtherCosts
Cost of personnel who do not work directly on the
product. Examples maintenance workers,
janitors and security guards.
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Manufacturing Overhead

• All other manufacturing costs

IndirectLabor
IndirectMaterial
OtherCosts
Examples depreciation on plant and equipment,
property taxes, insurance, utilities, overtime
premium, and unavoidable idle time.
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Classifications of Costs in Manufacturing
Companies

• Manufacturing costs are oftencombined as follows

DirectMaterial
DirectLabor
ManufacturingOverhead
PrimeCost
ConversionCost
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Cost Classifications on Financial Statements
Balance Sheet

• Merchandiser
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Merchandise Inventory

• Manufacturer
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Inventories
• Raw Materials
• Work in Process
• Finished Goods

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Cost Classifications on Financial Statements
Balance Sheet

• Manufacturer
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Inventories
• Raw Materials
• Work in Process
• Finished Goods

• Merchandiser
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Merchandise Inventory

Those materials waiting to be processed.
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Cost Classifications on Financial Statements
Balance Sheet

• Manufacturer
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Inventories
• Raw Materials
• Work in Process
• Finished Goods

• Merchandiser
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Merchandise Inventory

Partially complete products material to which
some labor and/or overhead has been added.
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Cost Classifications on Financial Statements
Balance Sheet

• Manufacturer
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Inventories
• Raw Materials
• Work in Process
• Finished Goods

• Merchandiser
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Merchandise Inventory

Completed products awaiting sale.
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Manufacturing Cost Flows
Balance
Sheet Costs
Inventories
Material Purchases
Raw Material
Direct Labor
ManufacturingOverhead
Selling andAdministrative
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Manufacturing Cost Flows
Income StatementExpenses
Balance
Sheet Costs
Inventories
Raw Material
Material Purchases
Work in Process
Direct Labor
ManufacturingOverhead
Cost of GoodsSold
FinishedGoods
Selling andAdministrative
Selling andAdministrative
Period Expenses
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Manufacturing Cost Flows
Income StatementExpenses
Balance
Sheet Costs
Inventories
Raw Material
Material Purchases
Work in Process
Direct Labor
ManufacturingOverhead
Cost of GoodsSold
FinishedGoods
Period expenses are not associated with
manufacturing the product and are expensed in
the period incurred.
Selling andAdministrative
Selling andAdministrative
Period Expenses
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Manufacturing Cost Flows
Income StatementExpenses
Balance
Sheet Costs
Inventories
Raw Material
Material Purchases
Work in Process
Direct Labor
ManufacturingOverhead
Cost of GoodsSold
FinishedGoods
Selling andAdministrative
Selling andAdministrative
Period Expenses
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Types of Production Processes
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Schedule of Cost of Goods Manufactured
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Schedule of Cost of Goods Manufactured
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Schedule of Cost of Goods Manufactured
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Schedule of Cost of Goods Manufactured
Include all direct labor costs incurred during
the current period.
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Schedule of Cost of Goods Manufactured
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Schedule of Cost of Goods Manufactured
Beginning work-in-process inventory is carried
over from the prior period.
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Schedule of Cost of Goods Manufactured
Ending work-in-process inventory contains the
cost of unfinished goods, and is reported in the
current assets section of the balance sheet.
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Income Statement for a Manufacturer
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Income Statement for a Manufacturer
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Income Statement for a Manufacturer
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Cost Classifications

• Cost behavior means how a cost will react to
  changes in the level of business activity.
• Total variable costs change when activity
  changes.
• Total fixed costs remain unchanged when activity
  changes.

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Cost Classifications
Activities thatcause costs to be incurred are
calledcost drivers.

• Cost behavior means how a cost will react to
  changes in the level of business activity.
• Total variable costs change when activity
  changes.
• Total fixed costs remain unchanged when activity
  changes.

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Identifying Cost Drivers
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Total Variable Cost Example

• Your total long distance telephone bill is
  based on how many minutes you talk.

Total Long DistanceTelephone Bill
Minutes Talked
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Variable Cost Per Unit Example

• The cost per long distance minute talked is
  constant. For example, 5 cents per minute.

Per MinuteTelephone Charge
Minutes Talked
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Total Fixed Cost Example

• Your monthly basic telephone bill probably
  does not change when you make more local calls.

Monthly Basic Telephone Bill
Number of Local Calls
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Fixed Cost Per Unit Example

• The average cost per local call decreases as more
  local calls are made.

Monthly Basic Telephone Bill per Local Call
Number of Local Calls
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Cost Classifications
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Cost Behavior Question

• Fixed costs are usually characterized by
• a. Unit costs that remain constant.
• b. Total costs that increase as activity
  decreases.
• c. Total costs that increase as activity
  increases.
• d. Total costs that remain constant.

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Cost Behavior Question

• Fixed costs are usually characterized by
• a. Unit costs that remain constant.
• b. Total costs that increase as activity
  decreases.
• c. Total costs that increase as activity
  increases.
• d. Total costs that remain constant.

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Cost Behavior Question

• Variable costs are usually characterized by
• a. Unit costs that decrease as activity
  increases.
• b. Total costs that increase as activity
  decreases.
• c. Total costs that increase as activity
  increases.
• d. Total costs that remain constant.

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Cost Behavior Question

• Variable costs are usually characterized by
• a. Unit costs that decrease as activity
  increases.
• b. Total costs that increase as activity
  decreases.
• c. Total costs that increase as activity
  increases.
• d. Total costs that remain constant.

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Direct and Indirect Costs

• Direct costs
• Costs that can beeasily and conveniently traced
  to a product or department.
• Example cost of paint in the paint department
  of an automobile assembly plant.

• Indirect costs
• Costs that must be allocated in order to be
  assigned to a product or department.
• Example cost of national advertising for an
  airline is indirect to a particular flight.

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Direct and Indirect Costs

• A cost can be direct to the department, but
  indirect to units of product produced in the
  department.
• Example department managers salary.
• Tracing costs directly to departments or products
  facilitates responsibility accounting.

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Controllable andUncontrollable Costs

• A cost that can be significantly influencedby
  a manager is a controllable cost.

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Opportunity Cost

• The potential benefit that is given up when one
  alternative is selected over another.
• Example If you werenot attending college,you
  could be earning20,000 per year. Your
  opportunity costof attending college for one
  year is 20,000.

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Sunk Costs

• All costs incurred in the past that cannot be
  changed by any decision made now or in the
  future.
• Sunk costs should not be considered in
  decisions.
• Example You bought an automobile that cost
  12,000 two years ago. The 12,000 cost is sunk
  because whether you drive it, park it, trade it,
  or sell it, you cannot change the 12,000 cost.

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Differential Costs

• Costs that differ between alternatives.

Example You can earn 1,500 per month in
yourhometown or 2,000 per month in a nearby
city.Your commuting costs are 50 per month in
yourhometown and 300 per month to the city.
What is your differential cost?
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Differential Costs

• Costs that differ between alternatives.

Example You can earn 1,500 per month in
yourhometown or 2,000 per month in a nearby
city.Your commuting costs are 50 per month in
yourhometown and 300 per month to the city.
What is your differential cost? 300 - 50 250
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Marginal Costs and Average Costs
The extra costincurred to produceone additional
unit.
The total cost toproduce a quantitydivided by
thequantity produced.
Marginal and average costs arelargely a function
of cost behavior -- variable and fixed costs.
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Costs and Benefits of Information
More information does not mean more benefits if
information overload results.
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End of Chapter 2