– Acct 362/562 Introduction to Cost Terminology

A variable cost is one that in total changes in direct proportion to a change in productive output; a fixed cost remains constant in total within a defined range of activity or time period. By classifying according to these patterns of behavior, managers can estimate how changes in selling prices or operating costs will affect profitability.

A value-adding cost is the cost of an activity that increases the market value of a product or service; a nonvalue-adding cost is the cost of an activity that adds cost to a product or service but does not increase its market value. Classifying costs as value-adding or nonvalue-adding enables managers to target opportunities for continuous improvement that lead to increased customer satisfaction.

Product costs , or inventoriable costs, are costs assigned to ; period costs , or noninventoriable costs, are costs of resources used during the but not assigned to products. Managers use these classifications in preparing financial statements.

All costs that relate to a factory would be product costs. The instant that a product is finished, then any additional costs incurred are period costs.

© 2014 by W. David Albrecht 53 There are a number of additional ways to classify different types of costs:

Variable cost Opportunity cost Fixed cost Sunk cost Mixed cost Discretionary cost Direct cost Marginal cost Indirect cost Average cost Overhead cost Relevant range

© 2014 by W. David Albrecht 54 Cost Accounting – Acct 352/562 Traditional

Sales $3,255 1,460 Gross margin 1,795 Selling 250 Administrative expense 160 R&D 300 Operating income 1,085 Interest revenue 25 Interest expense (85) Gains 5 Losses (20) Pre-tax income 1,010 Income tax expense 230 780

Sales revenue Beginning FG Beginning WIP Beginning Mat ! CGS + CGM + DM used + Mat Purchases GM CGAS + DL Total Mat available ! SG&A ! Ending FG + MOH ! Ending Mat Income CGS ! Ending WIP DM used CGM

CGS cost of goods sold GM gross margin S&A selling, general & administrative FG finished goods CGM cost of goods manufactured WIP work in process DM direct material DL direct labor MOH manufacturing overhead Mat material

© 2014 by W. David Albrecht 55 Calculating Income Statement Items

The income statement equations are:

Sales revenue Beginning FG Beginning WIP Beginning Mat ! CGS + CGM + DM used + Mat Purchases GM CGAS + DL Total Mat available ! SG&A ! Ending FG + MOH ! Ending Mat Income CGS ! Ending WIP DM used CGM

We shall now proceed to complete these equations with the information given in the following table:

Purchases of direct materials ...... 588 Customer service ...... 225 , VP’s office furniture ...... 92 Labor, sales force ...... 520 Direct labor ...... 729 Work in process inventory, 1/1/2012 ...... 130 Work in process inventory, 12/31/2012 ...... 170 Factory supervisors ...... 236 Maintenance, factory equipment ...... 195 Direct materials inventory, 1/1/2012 ...... 93 Direct materials inventory, 12/31/2012 ...... 82 Factory security ...... 82 Depreciation, finished goods warehouse ...... 110 Depreciation, factory building ...... 360 CEO’s salary ...... 90 Rent, corporate airplane for CEO ...... 36 Factory custodial personnel ...... 133 Finished goods inventory, 1/1/2012 ...... 176 Finished goods inventory, 12/31/2012 ...... 188 Sales revenue ...... 4,320

The equation furthermost to the right is a building block, and should be completed first.

Sales revenue Beginning FG Beginning WIP Beginning Mat 93 ! CGS + CGM + DM used + Mat Purchases 588 GM CGAS + DL Total Mat available 681 ! SG&A ! Ending FG + MOH ! Ending Mat –82 Income CGS ! Ending WIP DM used 599 CGM

© 2014 by W. David Albrecht 56 The next equation to be completed is the one for cost of goods manufactured (CGM). First, the amount of manufacturing overhead (MOH) must be computed:

Factory supervisors 236 Maintenance, factory equipment 195 Factory security 82 Depreciation, factory building 360 Factory custodial personnel 133 Total manufacturing overhead 1,006

This amount will now be entered into the cost of goods manufactured equation:

Sales revenue Beginning FG Beginning WIP +130 Beginning Mat +93 ! CGS + CGM + DM used +599 + Mat Purchases +588 GM CGAS + DL +729 Total Mat available 681 ! SG&A ! Ending FG + MOH +1,006 ! Ending Mat –82 Income CGS ! Ending WIP –170 DM used 599 CGM 2,294

Now that the cost of goods manufactured is computed, cost of goods sold can now be computed.

Sales revenue Beginning FG 176 Beginning WIP +130 Beginning Mat +93 ! CGS + CGM +2,294 + DM used +599 + Mat Purchases +588 GM CGAS 2,470 + DL +729 Total Mat available 681 ! SG&A ! Ending FG –188 + MOH +1,006 ! Ending Mat –82 Income CGS 2,282 ! Ending WIP –170 DM used 599 CGM 2,294

Now, selling and administrative must be computed for the income statement.

Selling Administrative Labor, sales force 520 Rent corp airplane 36 Deprec, FG warehouse 110 CEO salary 90 Customer service 225 Dep, VP off furn 92 Total 855 Total 218

Now there is sufficient information to complete the income statement.

Sales revenue 4,320 Beginning FG 176 Beginning WIP +130 Beginning Mat +93 ! CGS –2,282 + CGM +2,294 + DM used +599 + Mat Purchases +588 GM 2,038 CGAS 2,470 + DL +729 Total Mat available 681 ! Selling –855 ! Ending FG –188 + MOH +1,006 ! Ending Mat –82 ! Administrative –218 CGS 2,282 ! Ending WIP –170 DM used 599 Income 965 CGM 2,294

© 2014 by W. David Albrecht 57