Fundamentals of Cost Accounting 5th Edition by Lanen Anderson Maher ISBN Solution Manual

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Chapter 2
Cost Concepts and Behavior
Learning Objectives
1. Explain the basic concept of "cost."
2. Explain how costs are presented in financial statements.
3. Explain the process of cost allocation.
4. Understand how material, labor, and overhead costs are added to a product at each stage
of the production process.
5. Define basic cost behaviors, including fixed, variable, semivariable, and step costs.
6. Identify the components of a product's costs.
7. Understand the distinction between financial and contribution margin income statements.
© 2016 by McGraw-Hill Education. This is proprietary material solelyfor authorized instructor use. Not authorizedfor sale or
distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part. 2-1
Chapter Overview
I. WHAT IS A COST?
• Cost versus Expenses
II. PRESENTATION OF COSTS IN FINANCIAL STATEMENTS

• Service Organizations
• Retail and Wholesale Companies
• Manufacturing Companies
• Direct and Indirect Manufacturing (Product) Costs
• Prime Costs and Conversion Costs
• Nonrnanufacturing (Period) Costs
III. COST ALLOCATION

• Direct versus Indirect Costs
IV. DETAILS OF MANUFACTURING COST FLOWS
V. HOW COSTS FLOW THROUGH THE STATEMENTS

• Income Statements
• Cost of Goods Manufactured and Sold Statement
VI. COST BEHAVIOR

• Fixed Versus Variable Costs
VII. COMPONENTS OF PRODUCT COSTS

• Unit Fixed Costs Can Be Misleading for Decision Making
VII. HOW TO MAKE COST INFORMATION MORE USEFUL FOR MANAGERS

• Gross Margin versus Contribution Margin Income Statements
• Developing Financial Statements for Decision Making
Chapter Outline
I LO 2-1 Explain the basic concept of "cost."
WHAT IS A COST?
• Cost versus Expenses
o The cost accounting system records and maintains the use of economic resources by
the organization.
■
The financial statements prepared by the firm for external reporting use information from
the cost accounting system.
■
Cost accounting systems also provide information to help managers make better decisions.
Managers needto understand the common terms used in cost accounting.
■
Companies are interested in the costs of their products and services for many reasons.
■
See the Business Application box "Calculating the costs of E-Books versus Paper
Books."
o Cost represents a sacrifice of resources (typically cash or a line of credit). The price of
each item purchased measures the sacrifice made to acquire it.
■
Expense is a cost charged against (i.e., deducted from) revenue in an accounting
penod.
■
Cost initially recorded as an asset becomes an expense when the asset has been
consumed (e.g., the prepaid rent becomes rent expense after the office space has been
used for a penod of time). Generally accepted accounting principles (GAAP) and
regulations such as tax laws govern when and how costs are to be treated as expenses.
■
Cost accounting focuses on costs; expenses are referred to only in the context of
external financial reporting (in this text).
o The two major categories of costs are:
■
Outlay cost: a past, present, or future cash outflow, such as tuition, books, and fees paid
for a college education, and
■
Opportunity cost: the forgone benefit that could have been realized from the best
forgone alternative course of a resource, such as the time and income sacrificed to get
a college education.
See Demonstration Problem 1

distribution in any manner. This document may not be copied, scanned, duplicated,forwarded, distributed, or posted on a
• Managers tend to overlook or ignore opportunity costs while making decisions
because:
□
No one can ever know all possible opportunities available at any moment.
□
Typical accounting system only records outlay costs but not opportunity costs.
• Opportunity costs are relevant for managerial decisions and should be captured in
a well-designed cost accounting system.
I LO 2-2 Explain how costs are presented in financial statements.
PRESENTATION OF COSTS IN FINANCIAL STATEMENTS
• Operating profit is the excess of operating revenues over the operating costs incurred to
generate those revenues.
o Operating profit differs from net income.
o Net income is operating profit adjusted for interest, income taxes, extraordinary
items, and other adjustments required to comply with GAAP or other regulations.
o Information generated by the cost accounting system is used to help managers make
decisions that improve firm value. It is a means to an end.
■
Such information is best (in terms of relevancy) for various decisions but not
necessarily most accurate.
■
How the cost information is used in decision making and the costs of preparing and using
such information should also be considered.
o A generic income statement for a firm, a division, a product, or any unit has the following
format:
Income statement
Revenue XXX
Costs ()
Operating profit XXX
• Service Organizations
o Service organizations provide customers an intangible product, such as advice

and analyses. Labor costs and/or costs of information technology represent the
most significant cost category for service organizations.
o Exhibit 2.2 illustrates the income statement of a typical service company. Cost of services
sold includes costs of billable hours, which are the hours billed to clients plus the cost of
other items billed to clients. Costs that are not part of services billable to clients are
included in the marketing and administrative costs.
• Retail and Wholesale Companies
o Retail and wholesale companies sell but do not make a tangible product, such as
food, clothes, or a book.
o Exhibit 2.3 illustrates an income statement for a merchandising company. Cost of

goods sold keeps track of the tangible goods the company buys and sells.
o A typical income statement for a merchandising company has the following format:
Income Statement
Sales revenue XXX
Cost of goods sold (xx)
Gross margin XXX
Marketing and administrative costs (xx)
Operating profit XXX
o The cost of goods sold statement shows how the cost of goods sold was computed. The
typical format follows:
Cost of Goods Sold Statement
Beginning inventory XXX

Cost of goods purchased
Merchandise cost XXX
Transportation-in costs XXX
Total costs of goods purchased XXX
Cost of goods available for sale XXX
Less cost of goods in ending inventory (xx)
Cost of goods sold XXX
■
The gross margin reflects the amount available to cover marketing and administrative costs
and earn a profit.
■
Cost of goods sold includes only the actual costs of the goods that were sold. It does
not include the costs required to sell them, such as the salaries of salespeople, which
are marketing costs, or the salaries of top executives, which are admimstrative costs.
• Manufacturing Companies
o Manufacturing companies make the goods for sale and need to know the different
costs associated with making them.
• Direct and Indirect Manufacturing (Product) Costs
o Product costs are those costs assigned to units of production and recognized (i.e.,
expensed) when the product is sold. Product costs follow the product through inventory.
■
Direct manufacturing costs are product costs that can be identified with units (or
batches of units) at relatively low cost, including:
■
Direct materials are those that can be feasibly identified directly, at relatively low cost,
with the product. (For manufacturers, direct materials are purcliased parts, including
transportation-in.) Direct materials are often called raw materials.
■
Direct labor represents labor costs that can be identified with the product at reasonable cost.
Direct labor of workers transforms the materials into a finished product.
• Prime Costs and Conversion Costs
o Prime costs = Direct materials + Direct labor.

■
Companies with relatively low manufacturing overhead tend to focus on managing prime
costs.
• Indirect manufacturing costs are all product costs other than direct
manufacturing costs, often referred to in total as manufacturing overhead.
• Manufacturing overhead represents all other costs of transforming the materials

into a finished product, including:
□
Indirect labor (the cost of workers who do not work directly on the product, yet
are required so that the factory can operate, such as supervisors, maintenance
workers, inventory storekeepers, etc.)
□
Indirect materials (materials not a part of the finished product but are necessary to
manufacture it, such as lubricants, polishing and cleanmg materials, etc.)
□
Other manufacturing costs (expenses incurred to keep the factory running, such
as depreciation of tlie factory building and equipment, taxes and insurance on
the factory assets, heat, light, power, etc.)
• In practice, manufacturing overhead is also called factory burden, factory overhead,

burden, factory expense, or just overhead.
o Conversion costs = Direct labor + Manufacturing overhead.
■
Conversion costs are the costs that convert direct materials into the final product.
Companies with high direct labor and/or manufacturing overhead tend to emphasize
more about conversion costs.
• Exhibit 2.4 summarizes the relationship between prime costs, conversion costs, and
the three elements of manufactured product costs: direct materials, direct labor, and
manufacturing overhead.
• Nonrnanufacturing (Period) Costs
o Period costs (nonrnanufacturing costs are all other costs recognized for
financial reporting when incurred, including marketing and administrative costs.
■
Marketing costs are the costs required to obtain customer orders and provide
customers with finished products, including advertising, sales commissions, and
shipping costs.
■
Administrative costs are the costs required to manage the organization and provide
staff support, including executive and clerical salaries, costs for legal, financial, data
processmg, accounting services, and building space for administrative personnel.
o For financial accounting purposes, nonrnanufacturing costs are expensed in the period
incurred; for managerial purposes, however, these costs (especially advertising and
commissions) may be assigned to products.
• The distinction between manufacturing and nonrnanufacturing costs is not always clear-cut.
Companies usually set their own guidelines and follow them consistently.
o Service companies often have costs that are mostly indirect. Managing indirect costs is
extremely important in these firms if they are to remain profitable. (See Business
Application box "Indirect Costs in Banking.")
o Most firms are made up of activities that combine features of all three types of activities
(service, retailing, and manufacturing).
o In many of the firms which are usually considered to be of manufacturing type, virtually
all employees are engaged in service-related activities. (See Business Application box "A
New Manufacturing Mantra.")
I LO 2-3 Explain the process of cost allocation.
COST ALLOCATION
• Direct versus Indirect Costs
o Cost allocation is the process of assigning indirect costs to product, services, people,
business units, etc. Cost allocation is necessary when several departments share
facilities or services.
■
Cost object is any end to which a cost is assigned. Examples include a unit of product or
service, a department, or a customer.
■
Cost pool is the collection of costs to be assigned to the cost objects. Examples are
department costs, rental costs, or travel costs a consultant incurs to visit multiple
clients.
■
Cost allocation rule refers to the method or process used to assign costs in the cost pool
to the cost objects.
o Cost flow diagram is a diagram or flowchart illustrating the cost allocation process.
■
Fundamental approach to cost allocation:
• Identify the cost objects
• Determine the cost pools
• Select a cost allocation rule

■
Cost flow diagrams help managers understand
• How a cost system works
• The likely effects on the reported costs of different cost objects from changes in
the cost allocation rule.
■
Exhibit 2.5 illustrates an example of cost flow diagram.
• Direct cost is any cost that can be directly (unambiguously) related to a cost object at
reasonable cost; indirect cost is any cost that cannot be directly related to a cost object.
o A cost may be direct to one cost object and indirect to another.
o Whether a cost is considered direct or indirect also depends on the costs of linking it
to the cost object.
LO 2-4 Understand how material, labor, and overhead costs are added to a
product at each stage of the production process.
• Any production process involves three basic steps:
o Delivering direct materials to receiving area, inspecting, and then placing in direct
material inventory area (store).
o Transporting direct materials to an assembly line and undergoing the production

process. Work in process is a product in the production process but not yet complete.
o Moving the product to separate area in factory with other completed products. Finished
goods are products fully completed, but not yet sold.
• For manufacturing companies, there are three inventory accounts in a cost accounting system.
Each inventory account is likely to have the following structure (in T-account):
Inventory Account
(Direct materials, Work-in-process, or Finished goods)
Beginning inventory
Debit: Additions Credit: Withdrawals
Ending inventory
o Inventoriable costs are costs added (debited) to inventory accounts.
• The cost flows coincide with the physical flows of goods in and out of their respective storage
areas.
Direct materials inventory Work-in-process inventory Finished goods inventory
Beginning Less: Direct Beginning Beginning
inventory materials inventory inventory

Add: Purchases put into - Add: Less: Cost of Less: Cost of
Direct
PWoCuo materials goods Add: Cost of goods sold
Ending Add: Direct labor manufactured goods

inventory Add: manu actured
Manufacturing Ending inventory
overhead
Ending inventory
o The inventory account balances at the end of an accounting period appear on the balance
sheet as part of the current assets.
o If the company uses just-in-time (JIT) inventory people in direct materials receiving
department send the components to the assembly line immediately; if not, people in this
department send the components to a materials warehouse until it is needed for
production.
HOW COSTS FLOW THROUGH THE STATEMENTS
• Income Statements - Exhibit 2. 7 illustrates an income statement for a manufacturing firm.
• Cost of Goods Manufactured and Sold Statement Exhibit 2.8 illustrates a cost of goods
manufactured and sold statement for a manufacturing company.
o A typical cost of goods sold statement for a manufacturing company is more complicated
than that of a merchandising firm and has the following structure:
Cost of Goods Manufactured and Sold Statement

Beginning work-in-process inventory xx
Manufacturing costs during the year:
Direct materials
Beginning inventory xx
Add: Purchase of direct materials xx
Direct materials available xx
Less ending inventory (xx)
Direct material put into production xx
Direct labor xx
Manufacturing overhead xx
Total manufacturing costs incurred xx
Total work in process during the year xx
Less ending work-in-process inventory (xx)
Cost of goods manufactured xx
Beginning finished goods inventory xx
Finished goods available for sale xx
Less ending finished goods inventory (xx)
Cost of goods sold xx
■
The three shaded areas deal with direct materials, work-in-process, and
finished goods, respectively.
o The cost of goods manufactured and sold statement is prepared through the internal
reporting system and is for managerial use only.
o Total manufacturing costs incurred equals the sum of direct material put into
production, direct labor, and manufacturing overhead incurred during the period.
Managers in production and operations give careful attention to these costs.
o The total cost of work in process during the year (i.e., the sum of the beginning work-in•
process inventory and total manufacturing costs incurred) is a measure of the resources
that have gone into production.
o Cost of goods manufactured represents the cost of goods that were finished during the.
Production departments usually have a goal for goods completed each period.
Managers usually compare cost of goods manufactured to that goal to see whether the
production departments are successful in meeting it.
o Beginning finished goods inventory and cost of goods manufactured together determine
the cost of finished goods available for sale. The available finished goods either are
sold and become cost of goods sold, or are still on hand as part of the ending finished
goods inventory.
o The actual formats of financial statements vary a lot in practice. For managerial purposes,
it is important that the format be tailored to what users want.
LO 2-5 Define basic cost behaviors, including fixed, variable, semivariable,

and step costs.
COST BEHAVIOR
• Fixed Versus Variable Costs
o Cost behavior deals with the way costs respond to changes in activity levels; a cost driver
is a factor that causes, or "drives," costs.
■
Managers need to know how costs behave to make informed decisions about products, to
plan, and to evaluate performance.
■
Exhibit 2.9 illustrates the four cost behavior patterns to be discussed: fixed costs,
variable costs, semivariable costs, and step costs.
o Fixed costs are costs that are unchanged as volume changes within the relevant range of
activity. Examples: much of manufacturing overhead, many nonmanufacturing costs.
o Variable costs are costs that change in direct proportion with a change in volume within
the relevant range of activity. Examples: for manufacturing companies, direct materials,
and certain manufacturing overhead, direct labor in some cases; for merchandising
businesses, cost of the product, some marketing and administrative costs; for service
organizations, certain types of labor, supplies, copying, and printing costs.
The following graph shows a variable cost relationship between activity (units of
production) and the resulting cost of direct materials used.
Cost of Direct Materials
4d_((]ho
,[)0()I
fo'
1,000 1,500 Units
When the production volume is increased from 1,000 units to 1,500 units, it represents
a 50 percent increase in activity (i.e., 1, 500 -1, 000 x 100% = 50%). There is a
1,000
9respgnding 59,percent increase in direct materials costs as well (i.e.,
4,500 $3,000
x 100% = 50%). This example demonstrates the direct
and $3,000
proportionate relationship between activity and variable costs.
o Relevant range refers to the activity levels within which a given total fixed costs or
unit variable cost will be unchanged.
o A semivariable cost is a cost that has both fixed and variable components; also called
mixed cost. Examples: electric utility costs, phone charges.
o A step cost is a cost that increases with volume in steps; also called semifixed cost.
Examples: supervisors' salaries as each supervisor has a limited span of control.
o Four aspects of cost behavior complicate the task of classifying costs into fixed or
variable categories.
■
Not all costs are strictly fixed or variable.
■
Some costs increase with volume in "steps."
■
The cost relations are valid only within a relevant range of activity.
■
The classification of costs as fixed or variable depends on the measure of activity used.
I LO 2-6 Identify the components of a product's costs.
COMPONENTS OF PRODUCT COSTS
• Some cost concepts are determined by the rules of financial accounting. Some are more
useful for managerial decision making.
o Full cost is the sum of all fixed and variable costs of manufacturing and selling a unit
of product.
o Full absorption cost is the sum of all variable and fixed manufacturing costs. Full
absorption cost is used to compute a product's inventory value under GAAP; as such,
it excludes nonmanufacturing costs.
o Exhibit 2.11 illustrates the product cost components for a company.
o On a per-unit basis:
■
Full absorption cost = Direct materials + Direct labor+ Variable manufacturing
overhead+ Fixed manufacturing overhead.
■
Full cost= Full absorption cost+ Variable marketing and administrative costs+ Fixed
marketing and admimstrative costs.
■
Variable manufacturing cost = Direct materials + Direct labor + Variable
manufacturing overhead.
■
Variable cost = Variable manufacturing cost + Variable marketing and administrative cost.
o The diagram below demonstrates the relationship among various product cost
components.
I Direct materials
I'\_
Full absorption cost
.-D
--i-re_c_t_l-
ab_o_r
I Variable manufacturing overhead

I; · f
,1-+ v · bl
,=••
fa
gcos<
Full cost
. -°
Variable cost
I Fixed manufacturing overhead
I Variable marketing and administrative costs
Surketing au
nd adu
minista
rative costs
• Unit Fixed Costs Can Be Misleading for Decision
Making o Unit fixed costs are valid only at one volume.
o When fixed costs are allocated to each unit, accounting records often make the
costs appear as though they are variable.
o It is easy to interpret unit costs incorrectly and make incorrect decisions.
• Gross margin as reported in the external financial statements is the difference between
revenue and cost of goods sold, or
o Gross margin = Revenue -Cost of goods sold.
o Gross margin per unit = Sales price Full absorption cost per unit.
o Cost of goods sold = Full absorption cost per unit x Number of units sold.
o The income statement format that emphasizes gross margin is referred to as the
traditional income statement.
• Contribution margin per unit = Sales price Variable costs per unit. Contribution
margin is the amount available to cover fixed costs and earn a profit.
o The income statement format that emphasizes contribution margin is referred to as the
contribution margin income statement.
■
Exhibit 2.12 highlights gross margin information while Exhibit 2.13 showcases
contribution margin information. In both cases, the operating profit per unit remains
the same.
■
The interaction behind the calculations of gross margin per unit and contribution
margin per unit is presented below.
Traditional Contribution margin
Income Statement Components Income Statement
Sales price Sales price

Less: Full absorption cost = Variable manufacturing cost ----.
+ Fixed manufacturing cos~

ts Less: Variable cost
Gross margin Contribution margin
Less: Marketing and = Variable marketing and
administrative costs administrative cost
+ Fixed marketing and
administrative cost + Less; Fixed costs
Operating profit Operating profit
LO 2-7 Understand the distinction between financial and contribution

margin income statements.
HOW TO MAKE COST INFORMATION MORE USEFUL FOR MANAGERS
• Period costs can be determined once product costs are properly defined. Three approaches
to determining product costs are available.
o Full absorption costing (traditional income statement): As required by GAAP, all fixed
and variable manufacturing costs are product costs. All other costs are period costs.
o Variable costing (contribution margin income statement): Only variable manufacturing

costs are product costs. All other costs are period costs.
o Managerial costing: Management determines which costs are associated with the product.
Any new costs resulting from adding a product are considered product costs.
• Gross Margin versus Contribution Margin Income Statements
o A comparison of the first two income statement formats is shown below.

Gross Margin Contribution Margin
Income Statement Income Statement
Sales revenue Sales revenue

Less: Cost of goods sold Less: Variable costs
(including variable manufacturing costs (including variable manufacturing
and fixed manufacturing costs) and variable marketing and
administrative costs)
Gross margin Contribution margin
Less: Marketing and administrative costs Less: Fixed costs
(including variable marketing and (including fixed manufacturing and fixed
administrative costs and fixed marketing and administrative costs)
marketing and administrative costs)
Operating profit Operating profit
o Exhibit 2.14 illustrates the differences between gross margin and contribution
margin income statements.
o The product costs assigned to inventory are carried in the accounts as assets. When
the goods are sold, the costs flow from inventory to the cost of goods sold account of
the income statement.
• Developing Financial Statements for Decision Making
o The cost accounting system is designed to provide managers with relevant information
for decision making. Financial statements may be developed to serve special purposes.
o Case in point is the development of a value income statement that classifies costs into
value-added and nonvalue-added categories. By classifying activities as value added or
nonvalue added, managers are better able to reduce or eliminate nonvalue-added
activities and therefore reduce costs.
o Exhibit 2.15 illustrates a value income statement.
o Depending on the business and strategic environment of the firm, it is possible
to construct financial statements around activities related to quality,
environmental compliance, or new product development.
SUMMARY
• Exhibit 2.16 provides a summary of cost terms and definitions.
Matching
A. Administrative costs G. Full absorption cost

B. Conversion costs H. Indirect cost
C. Cost allocation I. Opportunity cost
D. Cost object J. Prime costs
E. Cost pool K. Semivariable cost
F. Direct cost L. Work in process
1. The foregone benefit from the best (forgone) alternative course of action.
2. Sum of direct labor and manufacturing overhead.
3. All variable and fixed manufacturing costs; used to compute a product's

inventory value under GAAP.
4. The process of assigning indirect costs to products, services, people, business units,
etc.
5. Any cost that cannot be directly related to a cost object.
6. Any end to which a cost is assigned.
7. Costs required to manage the organization and provide staff support.
8. Sum of direct materials and direct labor.
9. Collection of costs to be assigned to the cost objects.
10. A cost that has both fixed and variable components.
11. A product in the production process but not yet complete.
12. Any cost that can be directly (unambiguously) related to a cost object at
reasonable cost.
Matching Answers
1. I
2. B
3. G
4. C
5. H
6. D
7. A
8. J
9. E
10.K
11. L
12.F
Multiple Choice Questions
1. Which of the following statements about costs and expenses is correct?

a. A cost is a sacrifice of resources.
b. Cost and expense are the same.
c. All assets will become expenses.
d. There is no guidance as to when costs are to be treated as expenses.
2. A cost of goods sold statement for a retail business:

a. Includes transportation-in costs.
b. Has a cost of goods manufactured section.
c. Covers a period of time.
d. Both a and c.
3. A period cost:
a. Is also known as manufacturing cost.
b. Includes both marketing and administrative costs.
c. Will be expensed when products are sold.
d. Is part of cost of goods sold.
Use thefollowing information to answer questions 4 through 7:

A product is sold for $75 each with unit cost of direct materials $20, direct labor $15, variable
manufacturing overhead $12, and fixed manufacturing overhead $10. The volume produced
and sold is 6,000 units. Variable and fixed marketing and administrative costs are $4 and $3,
respectively.
4. Which of the following statements is correct?

a. Prime cost is $35.
b. Conversion cost is $37.
c. Inventoriable cost is $57.
d. All of the above.
5. What is the amount of cost of goods sold?

a. $342,000
b. $201,500
C. $364,000
d. None of the above.

a. Operating profit is $66,000.
b. Gross margin is $108,000.
c. Contribution margin is $144,000.
7. What is the full absorption cost per unit?
a. The same as full cost.
b. The same as inventoriable cost.
c. The full absorption cost per unit is $55.
d. The sum of variable manufacturing cost and variable marketing and administrative cost.
8. Which of the following statements regarding cost behavior within the relevant range is
incorrect?
a. Total fixed cost remains the same.
b. Fixed cost per unit remains constant.
c. Variable cost per unit remains constant.
d. Semivariable cost is also called mixed cost.
9. Unit fixed cost:

a. Is treated as variable cost when allocated to each unit.
b. Can be used for decision making under any circumstances.
c. Is misleading as the total fixed cost does not change.
d. Both a and c.
10. A value income statement:

a. Is developed for managerial decision making.
b. Distinguishes between value-added and nonvalue-added activities.
c. Is governed by GAAP.
d. Both a and b.

a. A cost object is any end to which a cost is assigned.
b. A cost pool is the collection of costs to be assigned to the cost objects.
c. A cost flow diagram is a diagram illustrating the cost allocation process.
12. The annual operating expense of running a copy center is shared by the three departments
that use its service: Human resource, Accounting, and Legal. Last year, the copy center
incurred $30,000 while HR copied 20,000 pages, Accounting 30,000 pages, and Legal
50,000 pages. What was Accounting department's share of the copy center cost?
a. $15,000
b. $6,000
c. $9,000
d. $7,500
Multiple Choice Answers
1. a (LOI)
2. d (LO2)
3. b (LO2)
4. d (LO4)
Prime cost= $20 + $15 = $35

Conversion cost= $15 + $12 +$10 = $37
Inventoriable cost= $20 + $15 + $12 +$10 = $57
5. a (LO4)
$57 X 6,000 = $342,000
6. d (LO4, LO7)
Gross margin= ($75 x 6,000)- $342,000 = $108,000

Operating profit= $108,000-[($4 + $3) x 6,000] = $66,000
Contribution margin= ($75 - $20 - $15 - $12$4) x 6,000 = $144,000
7. b (LO6)
8. b (LO5)
9. d (LO6)
10. d (LO7)
11. d (LO3)
12. c (LO3)
30,000
Accounting department's share of usage= 20,000 + 30, 000+ 50,000 x100% = 30%
Accounting department's share of cost= $30,000 x 30% = $9,000
Demonstration Problem 1
A developer plans to buy a parcel of land and construct an office building on top of it. He
narrows his search to two possible lots in adjacent states with convenient access to
highways. The expected returns from Lots C and Dare $190,000 and $210,000, respectively.
Required:
What is the opportunity cost of funds the developer uses to purchase Lot D?
Demonstration Problem 1- Solution
The opportunity cost of funds the developer uses to purchase Lot D is the forgone return the
developer could have earned from purchasing Lot C, assuming that both investments are equal
in risk and liquidity
Kahn Industry, Inc. has three divisions. The following information was available for last quarter.
Division A Division B Division C Company

Revenues $200,000 $320,000 $140,000 $660,000
Cost of goods (or services) sold 160,000 240,000 100,000 500,000
Gross margin $240,000 $ 80,000 $ 40,000 $160,000
Marketing and administrative costs 18,000 20,000 12,000 50,000
Operating profit $ 22,000 $ 60,000 $ 28,000 $110,000
Interest 10,000
Income taxes (30%) 30,000
Net income $ 70,000
The CEO of Kahn Industry wanted to allocate the interest cost of $10,000 to the three divisions.
Required:
1. Identify the cost object(s) and the cost pool.

2. Allocate the interest cost based on each division's (1) revenues, (2) gross margin, and (3)
operating profit.
3. Draw a cost flow diagram assuming the allocation of interest cost is based on revenues.
Demonstration Problem 2-- Solution
Part 1
The cost objects are the three divisions; the cost pool is the interest cost incurred for
the company as a whole.
Part 2
Division A Division B Division C Total

( 1) Revenues $200,000 $320,000 $140,000 $660,000
Allocation rule 30.3%° 48.5%° 21.2%° 100%
Allocation $3,030 $4,850 $2,120 $10,000
(2) Gross margin $40,000 $80,000 $40,000 $160,000

Allocation rule 25% 50% 25% 100%
Allocation $2,500 $5,000 $2,500 $10,000
(3) Operating profit $22,000 $60,000 $28,000 $110,000

Allocation rule 20.0% 54.5% 25.5% 100%
Allocation $2,000 $5,450 $2,550 $10,000
a
$200,000 + $660,000 = 0.303, or 30.3%.
b
$320,000 $660,000 = 0.485, or 48.5%.
$140,000 + $660,000= 0.212, or 21.2%.
Part 3
Cost Pool Interest cost
$10,000
% Revenues
Cost Allocation Rule
Cost Objects
30.3%
w
Division A
48.5%
w
Division B
21.2%
l
Divis ion C
$3,030 $4,850 $2, 120
The account balances are listed below for Eagle Manufacturing Company for the month of
March.
Finished goods inventory, March 31 $29,000

Direct materials purchases 70,000
Indirect labor 21,000
Direct labor 48,000
Work-in-process inventory, March 31 73,000
Factory supervisory salaries 12,000
Direct materials inventory, March 1 12,000
Factory utilities expense 4,000
Direct materials inventory, March 31 21,000
Work-in-process inventory, March 1 54,000
Factory depreciation expense 5,000
Finished goods inventory, March 1 33,000
Required:
Prepare a cost of goods manufactured and sold statement for Eagle Manufacturing Company
for the month ended March 31.
Demonstration Problem 3 -- Solution
Eagle Manufacturing Company Cost of Goods Manufactured and Sold Statement For the
month of March
Beginning work-in-process inventory $54,000

Direct materials
Beginning inventory $12,000
Add: Purchase of direct materials 70,000
Direct materials available $82,000
Less ending inventory (21,000)
Direct material put into production $61,000
Direct labor 48,000
Manufacturing overhead:
Indirect labor $21,000
Factory supervisory salaries 12,000
Factory utilities expense 4,000
Factory depreciation expense 5,000
Total manufacturing overhead 42,000
Total manufacturing costs incurred 151,000
Total work in process during the year $205,000
Less ending work-in-process inventory (73,000)
Cost of goods manufactured $132,000
Beginning finished goods inventory 33,000
Finished goods available for sale $165,000
Less ending finished goods inventory (29,000)
Cost of goods sold $136,000
Gourmet Industry manufactures pasta machines. The accountant of the company provides
the cost structure for each pasta machine produced as follows:
Variable manufacturing cost $ 85
Fixed manufacturing cost
(= Fixed manufacturing cost per year = $120, 000
Units produced per year 2,000 60
$145
The regular price for each pasta machine is $200. A regional restaurant chain wants to buy 150
pasta machines for $120 each. Gourmet Industry is also responsible for a one-time shipping
cost of $850. Marketing, administrative, total fixed costs, and regular sales are not affected by
the decision. Gourmet Industry has enough idle capacity to handle the order.
Required:
Determine if Gourmet Industry should accept the special order.
Demonstration Problem 4- Solution
By accepting the special order, Gourmet Industry will increase its operating profit by $4,400.
Revenues from special order ($120 x 150) $18,000

Variable manufacturing cost ($85 x 150) (12,750)
One-time shipping cost (850)
Contribution of special order to operating profit $4,400
The fixed manufacturing cost of $60 per unit will not affect the decision as the total fixed cost
remains unchanged. Based on the analysis, Gourmet Industry should accept the special order.
The following information is available for each unit of the finished product produced and sold:
Sales price $60

Variable manufacturing cost 20
Fixed manufacturing cost* 12
Variable marketing and administrative cost 6
Fixed marketing and administrative cost* 4
* The unit fixed manufacturing cost and fixed marketing and administrative costs are based on
an estimated volume of 6,000 units produced and sold.
Required:
Determine full absorption cost, variable cost, full cost, gross margin, contribution margin,
and operating profit per unit.
Full absorption cost= $20 + $12 = $32
Variable cost = $20 + $6 = $26
Full cost= ($20 + $12 + $6 + $4) = $42
Gross margin= $60- $32 = $28
Contribution margin = $60 -$26 = $34
Operating profit (from traditional income statement format)= $28 -($6 + $4) = $18 Operating
profit (from contribution margin income statement format)= $34 -($12 + $4) = $18
(Continuedfrom Demonstration Problem 5)
The following information is available for each unit of the finished product produced and sold:
Sales price $60

Variable manufacturing cost 20
Fixed manufacturing cost* 12
Variable marketing and administrative cost 6
Fixed marketing and administrative cost* 4
* The unit fixed manufacturing cost and fixed marketing and administrative costs are based on
an estimated volume of 6,000 units produced and sold.
Required:
Prepare a traditional income statement and contribution margin income statement when 6,000
units are produced and sold.
Traditional Contribution Margin
Income Statement Income Statement
Revenues $360,000 Revenues $360,000

Less: Cost of goods sold (192,000) Less: Variable cost (156,000)
Gross margin 168,000 Contribution margin 204,000
Less: Marketing and administrative costs (60,000) Less: Fixed costs (96,000)
Operating profit $108,000 Operating profit $108,000
© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or
Student Name: Instructor
Class: McGraw-Hill/Irwin
Exercise 02-41
MONROE FABRICATORS
Part a.
Beginning direct materials inventory $ 7,800
Transferred In 48,300
Transferred Out 43,800
Ending direct materials inventory $ 12,300
Correct!
Part b.
Cost of goods manufactured $ 163,350
Beginning work-in-process inventory 8,100
Ending work-in-process inventory 11,400
Total Manufacturing cost $ 166,650
Correct!
Part c.
Total manufacturing cost $ 166,650
L
Direct materials used $ 43,800
Manufacturing overhead 41,400
Direct labor $ 81,450
Correct!
Part d.
Gross margin $ 147,750
Cost of goods sold 168,150
Sales revenue $ 315,900
Correct!
Given Data E02-41:
MONROE FABRICATORS
Direct materials inventory, January 1 $ 7,800

Direct materials inventory, December 31 a. ?
Work-in-process inventory, January 1 8,100
Work-in-process inventory, December 31 11,400
Finished goods inventory, January 1 5,700
Finished goods inventory, December 31 900
Purchases of direct materials 48,300
Cost of goods manufactured during the year 163,350
Total manufacturing cost b. ?
Gross margin 147,750
Direct labor C. ?
Direct materials used 43,800
Sales revenue d. ?
Exercise 02-46
MADRID CORPORATION
Direct Materials $ 270
Direct Labor 165
Variable Manufacturing Overhead 60
Variable Manufacturing Costs $ 495
Variable Marketing and Administrative Cost 18

Unit Variable Cost $ 513
Fixed Manufacturing overhead: 90

Full-absorption Cost $ 585
Fixed Marketing and Administrative Cost 60

Full Cost of Making and Selling Product $ 663
«- Correct!
«- Correct!
«- Correct!
«- Correct!
Given Data E02-46:
MADRID CORPORATION
Information provided by accounting system:

Sales price (per unit) $ 900
Fixed costs (for the month)
Marketing and administrative $ 108,000
Manufacturing overhead $ 162,000

Variable costs (per unit)
Marketing and administrative $ 18
Direct materials $ 270
Manufacturing overhead $ 60
Direct labor $ 165
Units produced and sold (for the month) 1,800
Problem 02-54
CHELSEA, INC.
11
a. Total Prime Cost Computation
Beginning Inventory $ 9,000
Plus Purchases 120,000
Minus Ending Inventory 7,500
Direct materials 121,500
Direct Labor I 96,000
Prime Cost $ 217,500
Correct!
b. Total Conversion Cost Computation
EL
Direct Labor I $ 96,000
Manufacturing Overhead 126,000
Conversion Cost $ 222,000
Correct!
c. Total Manufacturing Costs Computation
Direct materials $ 121,500
= Direct Labor 96,000
Manufacturing Overhead 126,000
Total Manufacturing Costs $ 343,500
Correct!
d. Cost of Goods Manufactured Calculation
Beqinnina Work-in-Process $ 4,500
Total Manufacturing Costs 343,500
Ending Work-in-Process 3,000
=
Cost of Goods Manufactured $ 345,000
Correct!
e. Cost of Goods Sold Calculation
Cost of Goods Manufactured $ 345,000
Beginning Finished Goods Inventory 27,000
Ending Finished Goods Inventory 36,000
Cost of Goods Sold $ 336,000
Correct!
Given Data P02-54:
CHELSEA, INC.
Information provided by accounting records:

Direct materials inventory, May 1 $ 9,000
Direct materials inventory, May 31 7,500
Work-in-process inventory, May 1 4,500
Finished goods inventory, May 1 27,000
Direct materials purchased during May 120,000
Direct labor costs, May 96,000
Manufacturing overhead, May 126,000
Problem 02-56
COLUMBIA PRODUCTS
II
a. Computations
1. Variable Manufacturing Cost

Direct labor 35
Direct materials 112
Variable Manufacturing Cost $ 217
Correct!
2. Full Unit Cost
Fixed manufacturing $ 56
Fixed marketing and administrative cost 75
Direct labor 35
Variable overhead 70
Variable costs 14
Full Unit Cost $ 362
Correct!
3. Variable Cost per Unit
La
Variable cost $ 14
Variable overhead 70
Direct labor 35
Variable Cost $ 231
Correct!
4. Full Absorption Cost per Unit
Fixed manufacturing overhead $ 56
Variable manufacturing overhead 70
Direct labor 35
Full Absorption Cost $ 273
Correct!
5. Prime Cost per Unit
Direct labor $ 35
Prime Cost $ 147
Correct!
6. Conversion Cost per Unit
Direct labor $ 35
Manufacturing overhead 126
Conversion Cost $ 161
Correct!
7. Profit Margin per Unit
Sales price $ 448
Full cost 362
Profit Margin $ 86
Correct!
8. Contribution Margin per Unit
Sales price $ 448
Variable costs 231
Contribution Margin $ 217
Correct!
9. Gross Margin per Unit
Sales price $ 448
Full absorption cost 273
Gross Margin $ 175
Correct!
b. If the number of units decreases from 1,200 to 800, which is within the
relevant range, will the fixed manufacturing cost per unit increase,
decrease, or remain the same? Explain.
As the number of units increases (reflected in the denominator), fixed
manufacturing cost per unit decreases. The numerator (i.e., total fixed costs)
remains the same. However, that does not mean Columbia should produce
more units. That decision should be based on the total profits (revenues minus
costs), not on unit profits.
Given Data P02-56:
COLUMBIA PRODUCTS
Manufacturing costs:
Fixed overhead (for the month) $ 50,400
Direct labor (per unit) Direct 35
materials (per unit) Variable 112
overhead (per unit) 70
Marketing and administrative costs:
Fixed costs (for the month) $ 67,500
Variable costs (per unit) 14
Integrative Case 2-69
Tunes2Go
Drive Systems Division (DSD)
a. This year's income statement Baseline Rent
(status quo) Equipment Difference Chane
Sales Revenue $ 4,800,000 $ 4,800,000 $ -INo Change
Operating costs:
Variable (600,000 (600,000 -INo Change

Fixed (cash expenditures) (2,250,000 (2,250,000 -[No Change
Equipment depreciation (450,000 (450,000 -INo Change
Other depreciation (375,000 (375,000 -INo Change
Loss from equipment write-off - (2,550,000 2,550,000 Lower
Operating profit (before taxes) $ 1,125,000 $ (1,425,000 $ 2,550,000 Lower
Correct! Correct! Correct!
b. Next year's income statement Baseline Rent

(status quo) Equipment Difference
Sales Revenue $ 4,800,000TS 5,136,000[S 336,00[Higher
Operating costs:
Equipment rental - (690,000 690,000 Higher
Variable (600,000 (600,000 -INo Change
Fixed cash expenditures (2,250,000 (2,115,000 135,000 Lower
Equipment depreciation (450,000 - 450,000 Lower
Other depreciation (375,000 (375,000 -INo Change
Operating profit $ 1,125,000 $ 1,356,000 $ 231,000 Higher
Correct! Correct! Correct!
c. Would you rent the new equipment? Why or why not?

Despite the effect on next year's income statement, the company should not rent the new machine because net
cash inflow as a result of installing the new machine ($336,000 + $135,000) does not cover cash outflow for
equipment rental ($690,000).
Given Data IC2-69:
Tunes2Go
Cost of existing automated testing equipment $ 3,000,000
No salvage value
Annual rental charge for new testing machine $ 690,000

Percentage increase in DSD's annual revenue 7%
Percentage decrease in fixed cash expenditures 6%
Revenue and expense estimates without new machine:

Sales revenue $ 4,800,000
Variable operating costs 600,000
Fixed operating costs 2,250,000
Equipment depreciation 450,000
Other depreciation 375,000
© 2017 by McGraw-Hill Education. Thisis proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Cost Concepts and Behavior
l~ c_h_a_p_t_e_r_2~
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
► Copyright© 2017 by The McGraw-Hill Companies, Inc. All rights reserved.

2-3
Learning Objectives
LO 2-1 Explain the basic concept of "cost."

LO 2-2 Explain how costs are presented in financial statements.
LO 2-3 Explain the process of cost allocation.
LO 2-4 Understand how material, labor, and overhead costs are
added to a product at each stage of the production process.
LO 2-5 Define basic cost behaviors, including fixed, variable,
semivariable, and step costs.
LO 2-6 Identify the components of a product's costs.
LO 2-7 Understand the distinction between financial
and contribution margin income statements.
■What is a Cost? 2-4
LO 2-1 Explain the basic concept of "cost."
Cost is a sacrifice of resources.

2-5
Cost versus Expenses
Cost
, ,
Outlay Cost Opportunity Costs

Past, present, Forgone benefit from
or future cash the best alternative
outflow course of action
Expense
Cost charged against
.
revenue In an
accounting period
2-6
hp,esentation of Costs
in Financial Statements
LO 2-2 Explain how costs are presented in financial statements.
RPE ASSOCIATES
Income Statement
For the Year Ended December 31,Year 2
($000)
Cost of
Revenues ...................-...... $32,000 billable
---
Cost of services sold.................. 23,500 hours
Gross margin................-·... $ 8,500
Marketing and administrative costs....... 4,300
••]
«"....o....• necessary to generate those revenues
2-7
p,esentation of Costs in
Financial Statements
SOUTHWEST OFFICE PRODUCTS Expense assigned
Income Statement
For the Year Ended December 31, Year 2 to products sold
($000) during a period
Sales revenue . $3.22°
Cost of goods sold (see following statement) . 1,775
Gross margin . $1,450
Marketing and administrative costs . 825The excess of
Operating profit....................................... ? eratq

ingprevenue
Cost of Goods Sold Statement ver costs
For the Year Ended December 31, Year 2
($000)
necessary to
Beginning inventory . $ 300generate those
Cost of goods purchased
Merchandise cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,830 revenues
Transportation-in costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
Total cost of goods purchased . 1,920
Cost of goods available for sale . $2,220

Less cost of goods in ending inventory . 445
Cost of goods sold . $1,775
2-8
Epesentation of Costs
in Financial Statements
Cost incurred to manufacture
the product sold
Product costs recorded as

"inventory" when cost is incurred
Expense when sold JACKSON GEARS

Income Statement
For the Year Ending December 31, Year 2
($000)
Sales revenue. ............................................. $20,450

Cost of goods sold (see Exhibit 2.8) . 13,100
Gross margin . $ 7,350

Less marketing and administrative costs 3,850
Operating profit before taxes . $ 3,500
Period costs recorded as
an expense in the period
the cost is incurred
2-9
Product versus Period Costs

Two types of manufacturing costs:
Product costs: Period costs: Non-
Costs related to manufacturing costs
inventory related to the firm
2-10
Product versus Period Costs
Product costs: Costs

that are recorded
as an asset in inventory when
incurred and expensed as
Cost of Goods Sold when sold
Period costs:
Costs recognized for financial
reporting when incurred
2-11
Ehp;rect and Indirect

Manufacturing Costs
Direct costs:
Costs that, for a reasonable cost, can
be directly traced to the product.
, y
Direct materials: Direct labor:

Materials directly Work directly traceable to
traceable to the product transforming materials
into the finished product
2-12
Ehp;rect and Indirect

Manufacturing Costs
Indirect costs:
Costs that cannot reasonably be
directly traced to the product.
Manufacturing overhead: All

production costs except direct
materials and direct labor.
! ¥ l
Indirect materials Indirect labor Other indirect costs
2-13
Prime Costs and Conversion Costs
~ Direct
-
Prime costs: materials
The "primary" costs
of the product Direct
-
labor
Conversion costs: Direct

-
Costs necessary to labor

"convert" materials Manufacturing
into a product -
overhead
2-14
Non-manufacturing (Period) Costs

Recognized as expenses when the costs are incurred
~
"
Advertising
Marketing:
Costs necessary to . Sales commissions ]
sell the products I I ' - Shipping costs
~
Executive salaries
Administrative: Costs
necessary to operate • [Data processing ]
the business I
I I - -Legal costs
~
I 2-15
Cost Allocation
LO 2-3 Explain the process of cost allocation.
It is the process of assigning indirect costs to

products, services, business units, etc.
EH 2-16
Cost Allocation
1. Define the cost pool:

The collection of costs to be assigned to cost objects
2. Determine the cost allocation rule:
The method used to assign costs in the cost
pool to cost objects
3. Assign the costs in the cost pool to the cost object:
Any end to which a cost is assigned - product,
product line, department, customer, etc.
I 2-17
Cost Allocation: Example

Rockford Corporation has two divisions, East Coast and
West Coast. Both divisions are supported by the IS Group.
East Coast West Coast Total

Revenues $80 million $20 million $100 million
1. Define the cost pool: IS department's costs of $1,000,000
2. Determine the cost allocation rule: IS costs are allocated based on

divisional revenue. (% of revenue)
3. Assign to the cost object: East Coast: 80% of cost

West Coast: 20% of cost
2-18
Cost Flow Diagram
Cost Corporate IS Group

pool $1 ,000,000
Cost
allocation 80%a %0 Revenue 20%b
rule
g ,.
Cost East Coast West Coast

objects $800,000 $200,000
a
80% = $80 million revenue -=- ($80 million + $20 million) b 20% = $20 million revenue --;- ($80 million+ $20 million)
2-19
Details of Manufacturing Cost Flows
LO 2-4 Understand how material, labor, and overhead costs are

added to a product at each stage of the production process.
Product costs are recorded in inventory when costs are incurred.

A manufacturing company has three inventory accounts:
1. Raw Materials Inventory:
Materials purchased to make a product
2. Work-in-Process Inventory:
Products currently in the production process,
but not yet completed
3. Finished Goods Inventory:
Completed products that have not yet been sold
2-20
Inventory Accounts -The Balance Sheet
Direct Materials Work-in-Process Finished Goods

Inventory Inventory Inventory
Beg. RM inventory Beg. WIP inventory Beg. FG inventory

+ Purchases + Direct materials + Cost of goods
r transferred from J completed and
- Raw materials
raw materials transferred from WI P
available for
production + Direct labor - Goods available

for sale
- Ending RM inventory + Manufacturing overhead
- Raw materials - Total manufacturing costs - Ending FG inventory
-
transferred to WIP - Cost of goods sold
- Ending WIP inventory
- Costs of goods completed

,.
and transferred to
finished goods (or cost of - To the Income
goods manufactured) Statement
Ehl Costs Flow Through the
2-21
Statements
JACKSON GEARS
Income Statement
For the Year Ending December 31, Year 2
($000)
Sales revenue . $20,450

Cost of goods sold (see Exhibit 2.8) . 13,100
Gross margin . $ 7,350

Less marketing and administrative costs . 3,850
Operating profit before taxes . $ 3,500
2-22
Statements
JACKSON GEARS
For the Year Ending December 31, Year 2 (S000)
Beginning work-in-process inventory, January 1 . $270
Direct materials:
Beginning inventory, January 1 $ 95
Add purchases... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,627
Less ending inventory, December 31. . . . . . . . . . . . . . . . 72
Direct material put into production . . . . . . . . . . . . . . . . . $5,650
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,220
Manufacturing overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,780
Total manufacturing costs incurred . 13,650
Total work in process during the year . $13,920
Less ending work-in-process inventory, December 31 . 310
Cost of goods manufactured . $13,610
Next, determine the cost of goods sold.

2-23
Statements
JACKSON GEARS
For the Year Ending December 31, Year 2 (S000)
Beginning work-in-process inventory, January 1 .
Manufacturing costs during the year: $270
Direct materials:
Beginning inventory, January 1 $ 95
Add purchases.................................. 5,627
Less ending inventory, December 31 . . . . . . . . . . . . . . . . 72
Direct material put into production . . . . . . . . . . . . . . . . . $5,650
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,220
Manufacturing overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,780
Total manufacturing costs incurred . 13,650
Total work in process during the year . $13,920
Less ending work-in-process inventory, December 31 . 310
Cost of goods manufactured . $13,610
Beginning finished goods inventory, January 1 . 420
Finished goods available for sale . $14,030
Less ending finished goods inventory, December 31 . 930
Cost of goods sold . $13,100
2-24
Cost Behavior
LO 2-5 Define basic cost behaviors, including fixed,

variable, semivariable, and step costs.
Cost behavior:
How costs respond to a change in
activity level within the relevant range
Relevant range:
Activity levels within which a given total fixed
cost or unit variable cost will be unchanged
2-25
Fixed Costs
Fixed costs in total remain unchanged as volume
changes within the relevant range.
-
Fixed costs per unit varies inversely to a change in
activity.
[Fixed costs are "fixed" in "total" as activity changes.
Cost($)
30
25
20
□ Total Fixed
15 Cost
10•
0 I I I
Activity Level 0 1 2 3 4
2-26
Variable Costs
Costs that change in direct proportion with a
change in the volume within the relevant range
-
Variable costs "vary" in "total" as activity changes.
Variable cost per unit stays constant when
activity changes within the relevant range.
Cost($)
35
30
25
20 □ Total Variable
Cost
15
10
5
0
2-27
Relevant Range
120000
0
100000
l
0
0
80000
(_)
o 60000
Q)
X
·- 40000
LL
20000
0 I I I
0 1000 2000 3000 4000 5000 6000
Volume
2-28
Semivariable Costs
Costs that have both fixed
and variable components
Also known as mixed costs
Cost($)
35
30
25
20 □ Semivariable
Cost
15
10
5
0
2-29
Step Costs
Costs that increase in total with steps when the
volume changes to a particular level.
---- Also known as semifixed costs. ~---~
Cost($)
35
30
25
20 I
15 I
10 I
5 -
0 I I I I
II 2-30
Components of Product Costs
LO 2-6 Identify the components of a product's costs.
Full cost:
The sum of all costs of manufacturing
and selling a unit of the product
Full absorption cost:

The sum of all variable and fixed costs
of manufacturing a unit of the product
Variable cost:
The sum of all variable costs of manufacturing
and selling a unit of the product
II 2-31
Components of Product Costs

4 l
Direct materials = $8
I l Variable
manufacturing
•
Full
Direct labor = $7 cost= $23
absorption ,
cost per unit
Full cost
= $29 Variable manufacturing r Unit
variable
overhead = $8
per unit cost= $27
l
= $40 Fixed manufacturing

,, Variable
overhead = $6
marketing and
Variable marketing and administrative
ht costs= $4
administrative costs = $4
Fixed marketing and

, administrative costs = $7
2-32
Making Cost Information Useful

LO 2-7 Understand the distinction between financial
and contribution margin income statements.
Full absorption costing: Variable costing:

• Required by GAAP • Used for:
• Used for: - Managerial purposes
- Financial purposes - Internal decision
- External reporting making
Sales revenue Sales revenue

- Cost of goods sold - Variable costs
= Gross margin = Contribution margin
2-33
Making Cost Information Useful
Financial income Contribution margin

statement income statement
lr
' Variable
Full absorption costing
costing
'
Sales price
ir
Sales price
- Variable costs
- Full absorption cost
= Contribution margin
= Gross margin
El,, come Statement: 2-34
Full Absorption Costing
_.,
Full absorption
Sales revenue
,,
Variable and fixed

- Cost of goods sold
manufacturing costs
= Gross margi. n
I Period costs
- Marketing and I
administrative costs
-· ,,
Variable and fixed

marketing and
= Operating profit
2-35
Income Statement:
Variable Costing
Variable manufacturing costs

Sales revenue
+ and variable marketing
and administrative costs
- Variable costs
= Contribution margin
- Fixed costs
Fixed manufacturing costs
-
and fixed marketing and
= Operating profit
2-36
End of Chapter 2
Student Name:
Class:
Exercise 02-41
MONROE FABRICATORS
Part a.
Beginning direct materials inventory
Transferred In
Transferred Out
Ending direct materials inventory
Part b.
Cost of goods manufactured
Beginning work-in-process inventory
Ending work-in-process inventory
Total Manufacturing cost
Part c.
Total manufacturing cost
Direct materials used
Manufacturing overhead
Direct labor
Part d.
Gross margin
Cost of goods sold
Sales revenue
Given Data E02-41:
MONROE FABRICATORS
Direct materials inventory, January 1 $ 7,800

Direct materials inventory, December 31 a. ?
Work-in-process inventory, January 1 8,100
Work-in-process inventory, December 31 11,400
Finished goods inventory, January 1 5,700
Finished goods inventory, December 31 900
Purchases of direct materials 48,300
Cost of goods manufactured during the year 163,350
Total manufacturing cost b. ?
Gross margin 147,750
Direct labor C. ?
Direct materials used 43,800
Sales revenue d. ?
Student Name:
Class:
Exercise 02-46
MADRID CORPORATION
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Variable Manufacturing Costs
Variable Marketing and Administrative Cost

Unit Variable Cost
Fixed Manufacturing overhead:

Full-absorption Cost
Fixed Marketing and Administrative Cost

Full Cost of Making and Selling Product
Given Data E02-46:
MADRID CORPORATION

Fixed costs (for the month)
Marketing and administrative $ 108,000
Manufacturing overhead $ 162,000

Variable costs (per unit)
Marketing and administrative $ 18
Direct materials $ 270
Direct labor $ 165
Units produced and sold (for the month) 1,800
Student Name:
Class:
Problem 02-54
CHELSEA, INC.
a. Total Prime Cost Computation
Direct materials
Prime Cost
b. Total Conversion Cost Computation

I
Conversion Cost
c. Total Manufacturing Costs Computation
Total Manufacturing Costs
d. Cost of Goods Manufactured Calculation
Cost of Goods Manufactured
e. Cost of Goods Sold Calculation
Cost of Goods Sold

Given Data P02-54:
CHELSEA, INC.
Information provided by accounting records:

Direct materials inventory, May 1 $ 9,000
Direct materials inventory, May 31 7,500
Direct materials purchased during May 120,000
Direct labor costs, May 96,000
Manufacturing overhead, May 126,000
Student Name:
Class:
Problem 02-56
COLUMBIA PRODUCTS
a. Computations
1. Variable Manufacturing Cost
Variable Manufacturing Cost
2. Full Unit Cost
Full Unit Cost
3. Variable Cost per Unit
Variable Cost
4. Full Absorption Cost per Unit
Full Absorption Cost

5. Prime Cost per Unit
Prime Cost
6. Conversion Cost per Unit
Conversion Cost
7. Profit Margin per Unit
Profit Margin
8. Contribution Margin per Unit
Contribution Margin
9. Gross Margin per Unit
Gross Margin
b. If the number of units decreases from 1,200 to 800, which is within the
relevant range, will the fixed manufacturing cost per unit increase,
decrease, or remain the same? Explain.
Given Data P02-56:
COLUMBIA PRODUCTS
Manufacturing costs:
Fixed overhead (for the month) $ 50,400
Direct labor (per unit) Direct 35
materials (per unit) Variable 112
overhead (per unit) 70
Marketing and administrative costs:
Fixed costs (for the month) $ 67,500
Variable costs (per unit) 14
Student Name:
Class:
Integrative Case 2-69
Tunes2Go
a. This year's income statement Baseline Rent
(status quo) Equipment Difference Change
Sales Revenue
Operating costs:
Variable
Fixed (cash expenditures)
Equipment depreciation
Other depreciation
Loss from equipment write-off
Operating profit (before taxes)
b. Next year's income statement Baseline Rent

(status quo) Equipment Difference
Sales Revenue
Operating costs:
Equipment rental
Variable
Fixed cash expenditures
Equipment depreciation
Other depreciation
Operating profit
c. Would you rent the new equipment? Why or why not?

Given Data IC2-69:
Tunes2Go
Cost of existing automated testing equipment $ 3,000,000
No salvage value
Annual rental charge for new testing machine $ 690,000

Percentage increase in DSD's annual revenue 7%
Percentage decrease in fixed cash expenditures 6%
Revenue and expense estimates without new machine:

Sales revenue $ 4,800,000
Variable operating costs 600,000
Fixed operating costs 2,250,000
Equipment depreciation 450,000
Other depreciation 375,000

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Solution manual for Fundamentals of Cost

Accounting 5th Edition by Lanen

2. Explain how costs are presented in financial statements.

3. Explain the process of cost allocation.

6. Identify the components of a product's costs.

II. PRESENTATION OF COSTS IN FINANCIAL STATEMENTS

III. COST ALLOCATION

IV. DETAILS OF MANUFACTURING COST FLOWS

V. HOW COSTS FLOW THROUGH THE STATEMENTS

VI. COST BEHAVIOR

VII. COMPONENTS OF PRODUCT COSTS

VII. HOW TO MAKE COST INFORMATION MORE USEFUL FOR MANAGERS

I LO 2-1 Explain the basic concept of "cost."

• Cost versus Expenses

o The two major categories of costs are:

See Demonstration Problem 1

I LO 2-2 Explain how costs are presented in financial statements.

PRESENTATION OF COSTS IN FINANCIAL STATEMENTS

o Operating profit differs from net income.

o Service organizations provide customers an intangible product, such as advice

• Retail and Wholesale Companies

o Exhibit 2.3 illustrates an income statement for a merchandising company. Cost of

Cost of Goods Sold Statement

Beginning inventory XXX

• Direct and Indirect Manufacturing (Product) Costs

• Prime Costs and Conversion Costs

o Prime costs = Direct materials + Direct labor.

• Manufacturing overhead represents all other costs of transforming the materials

• In practice, manufacturing overhead is also called factory burden, factory overhead,

o Conversion costs = Direct labor + Manufacturing overhead.

• Nonrnanufacturing (Period) Costs

I LO 2-3 Explain the process of cost allocation.

• Direct versus Indirect Costs

• Identify the cost objects

• Determine the cost pools

• Select a cost allocation rule

• How a cost system works

See Demonstration Problem 2

o A cost may be direct to one cost object and indirect to another.

• Any production process involves three basic steps:

o Transporting direct materials to an assembly line and undergoing the production

o Inventoriable costs are costs added (debited) to inventory accounts.

Beginning Less: Direct Beginning Beginning

inventory materials inventory inventory

PWoCuo materials goods Add: Cost of goods sold

Ending Add: Direct labor manufactured goods

HOW COSTS FLOW THROUGH THE STATEMENTS

• Income Statements - Exhibit 2. 7 illustrates an income statement for a manufacturing firm.

Cost of Goods Manufactured and Sold Statement

See Demonstration Problem 3

LO 2-5 Define basic cost behaviors, including fixed, variable, semivariable,

• Fixed Versus Variable Costs

Cost of Direct Materials

1,000 1,500 Units

proportionate relationship between activity and variable costs.

I LO 2-6 Identify the components of a product's costs.

COMPONENTS OF PRODUCT COSTS

o Exhibit 2.11 illustrates the product cost components for a company.

I Variable manufacturing overhead

I Variable marketing and administrative costs

• Unit Fixed Costs Can Be Misleading for Decision

Making o Unit fixed costs are valid only at one volume.

o It is easy to interpret unit costs incorrectly and make incorrect decisions.