MANAGERIAL ACCOUNTING

information systems to capture both quantitative and qualitative data, to

CHAPTER 1 collect and organize those data into useful information and to transform
that information into knowledge that can be communicated throughout
an organization.
Introduction to Managerial Accounting In order to provide managers with the information they need to
make effective business decisions, financial data must be linked to
Business environments have changed dramatically in the past few nonfinancial data, transformed into useful information and knowledge,
decades. Companies of all sizes can now compete in a dynamic global and communicated throughout an organization.
marketplace through electronic commerce (e-business) and other
emerging technologies. Downsizing, combined with a more mobile
workforce, has placed a premium on retaining talented, knowledgeable
employees. Customer demand specialized products and services and
real-time information concerning product availability, order status, and
delivery times. Suppliers need information on their buyer’s sales and
inventory levels in order to tailor their production schedules and
delivery times to meet the buyers’ demands. Although these changes
have provided opportunities for those companies which are able to
adapt the take advantage of them, they have also resulted in challenges.
Such changes require more effective management of knowledge within
an
organization.
In today’s business environment, knowledge is power and must be
managed for a company to remain competitive. Knowledge should not
be confused with data or information. Companies generally literally
tons of data - - financial statements, customer lists, inventory records,
and the number and type of products and services sold. Translating COMPARISON OF FINANCIAL AND MANAGERIAL
those data into an accessible and usable form is another matter. When ACCOUNTING
data are organized, processed, and summarized they become
information. When FINANCIAL ACCOUNTING – is the area of accounting concerned
information is shared and exploited so that it adds value to an primarily with the preparation of general-use financial statements for
organization, it becomes knowledge creditors, investors, and other users outside the company (external
All type of organizations, from large multinational manufacturing users).
companies to small manufacturers need accounting information. Even
retailers, locally owned stores, large service companies, local certified MANAGERIAL ACCOUNTING – is concerned primarily with
pubic accounts law firms and nonprofit organizations and even generating financial and nonfinancial information for use by managers
homeless in their decision-making roles within a company (internal users). This
shelters need accounting information. information typically is not shared with those outside the company.
Accounting information is used by internal managers in their day-to- Although both financial accounting information and managerial
day decision making and also be external users, such as inventors, accounting information generated from the same AIS, the information is
creditors, donors and even the Internal Revenue Service. used in different ways by the various stockholders of the company.

ACCOUNTING INFORMATION A stakeholder is any person or group that either affects or is affected
Is provided by a company’s Accounting Information System (AIS). by the company’s actions and decisions. Stakeholders include both
AIS was simply a transaction- processing system that captured financial external and internal users of information .
data resulting from accounting transactions. Example: the AIS would
document a transaction to purchase materials by recording a journal EXTERNAL USERS
entry showing the date of purchase, an increase to raw materials Stockholders, potential investors, creditors, government taxing agencies
inventory, and a corresponding increase to accounts payable or decrease and regulators, suppliers, and customers are all external users.
in cash. Under this view of AIS, accounting information was simply
financial information WHAT TYPE OF INFORMATION DO EXTERNAL USERS NEED?
(sales, net income, total assets, costs of products, and so on) expressed Stockholders and potential inventors wants information to help
in terms of peso or other monetary units (e.g. dollars, yen, euros) Other, them analyze the current and future probability of an organization.
non-financial information such as the number of units of materials or Companies that have issued stock to
inventory on hand, the number of budgeted labor hours to produce a the public provide this information in the form of:
product, the number of units necessary to break even, and the time it  Annual report
takes the manufacture a product – were likely collected and processed  Registration statements
outside the traditional AIS. The use of multiple information systems  Prospectuses
within a company causes a number of problems. It is costly to support  Other reports issues to shareholders, potential investors and
multiple systems. Perhaps more important, it is difficult to integrate SEC.
information coming from various systems to make decision for a The information required in this report and the accounting
company with multiple sources of information. methods used to prepare them are governed by the Financial
Over the past few years, enterprise resource planning (ERP) Accounting Standards Board (FASB) and the SEC.
systems have been developed in an attempt to address these
shortcomings. ERP systems integrate the traditional AIS with other
What about smaller companies that are owned by just a few members of Operating activities encompasses what managers must do to run the
a family (called closely held companies) or nonprofit organization, such business on a day-to-day basis. Operating decisions for manufacturing
as the Red Cross? companies includes whether to accept special orders, how many parts
of other raw materials to buy, whether to sell a product or to process it
External users of financial information, such as bank or potential further, whether to schedule overtime, which products to produce, and
donors to nonprofit organizations still needs accounting information to what prices to charge.
make the proper decision about lending or donating money. However, Other operating decisions affecting all organizations include
these needs may differ from those of stockholders and potential assigning tasks to individual employees, choosing whether to advertise,
inventors. and choosing whether to hire fulltime employees or to outsource.

Creditors generally want to assess a company’s overall financial health Controlling Activities
and may be particularly interested in a company’s cash flow and ability Controlling activities involve the motivation and monitoring of
to repay its loans. employees and the evaluation of people and other resources used in the
organization’s operation. The purpose of control is to make sure that the
Potential contributors to nonprofit organization may have a need for goals of the organization are being attained. It includes using incentives
both financial information such as how much of the Red cross budget is and other rewards to motivate employees to accomplish an organization
spent for charitable purposes, and nonfinancial information, such as goal and using mechanisms to detect and correct deviations from those
how many women with children are served by the local homeless goals.
shelter. Control often involves the comparison of actual outcomes (cost
products, sales, and so on) with desires outcomes (as stated in the
Government agencies (federal, state, and local) have very specific organization’s operating and strategic plans).
information needs, including the measurement of income payroll, and Control decisions includes questions of how to evaluate
assets for purposes of assessing taxes. This accounting information is performances, what measures to use, and what types of incentives to
typically provided on income tax returns, payroll reports, and other implement.
forms designed specifically to meet the requirements of each agency. Example: a company that emphasizes high-quality products and
excellent
Generally, accounting information provided to shareholders, creditors, customer services may evaluate the reward production workers who
and government agencies is characterized by a lack of flexibility, the have exceeded goals that are based on their virtues.
reporting of past events by using historical costs (financial statements
for the previous three years) and an emphasis on the organization as a THE FUNCTIONAL AREAS OF MANAGEMENT
whole. Managers are found in all functional areas of an organization,
Suppliers and customers are also external users. However, their including
accounting information needs are likely to be very different from those operations and production, marketing, finance and human resources.
of other external users and may be more clearly aligned with the needs Although managers rely on the same information provided to external
of internal users. users, they have other needs as well.
 OPERATION AND PRODUCTION FUNCTION
INTERNAL USERS It produces the products or services that an organization sells to its
Internal users of accounting information include individual employees customers. Operations and production managers are concerned with
as well as teams, departments, regions, and top management of an providing quality products and services that can compete in global
organization. marketplace. They need accounting information to make planning
These internal users are often referred to as managers. Managers decisions affecting how and when products are produced and services
involved in three primary activities, commonly referred to as planning, provided.
operating, and controlling. The need to k now the costs of producing and storing products in
1. Planning activities - it involves the development of both the short- order to decide how much inventory to keep on hand. The need to know
term the costs of labor when making decisions on whether to schedule
(operational) and long-term (strategic) objectives and goals of an overtime to complete a production run or when deciding how many
organization and the identification of the resources needed to achieve physicians are needed in an emergency room.
them. These decisions are influenced by information provided by the
 Operating planning - involves the development of short- marketing managers, including the expected customer reaction if
term objectives and goals (typically, those to be achieved in products are not available when orders are placed or if doctors are not
less than one year). available when patients need them.
Examples: 1) Ben & Jerry’s 2) Hospitals
Operating planning is also involves determining short-term  THE MARKETING FUNCTION
performance goals and objectives, including meeting customer service It involves it the process of developing, pricing, promoting, and
expectations, sales quotas, and time budgets. distributing
 Strategic planning - addresses long-term questions of how goods and services sold to customers.
organization positions and distinguishes itself with respect to Marketing managers need to know how much a product costs in
competitors. Example: Ben & Jerry’s (for producing order to help establish a reasonable selling price. They need to know
high-quality ice-cream is very different from that used by a how a given advertising campaign and its resulting impact on the
company producing a store brand of lower priced ice cream. ) number of units sold is expected to affect income. They need to know
how enhancing product’s features or changing its packaging will
Strategic planning also involves the determination of long-term influence a cost. Commissions paid to sales representatives may be
performance and profitability measures, such as market share, sales based on a company’s profit. All these marketing decisions require
growth, and stock price. accounting information.

2. Operating Activities  THE FINANCE FUNCTION

 The finance function is responsible for managing the financial in inventory). This
resources of the organization. Finance managers make decisions about information is often
how to raise capital as well as where and how to invest it. provided in
Finance managers need accounting information to answer such summary form (for
questions as whether money should be raised through borrowing the company as a
(issuing bonds) or selling stocks. Finance managers also make decisions whole) and
concerning whether a new piece of manufacturing equipment should be typically is
historical in nature.
purchased or leased and whether a plant expansion should be paid for in
External Government Varies by agency Tax returns
cash or by borrowing money from the bank.
agencies but includes taxable and other
income, sales, reports
 THE HUMAN RESOURCE FUNCTION assets, comparisons
Although all managers who supervise, motivate, and evaluate other of actual
employees are human resource managers, the human resource expenditures with
function is concerned with the utilization of human resources to help budgets, etc. This
an organization reach its goals. information is
More specifically, human resource managers support other usually provided
functions and managers by recruiting and staffing, designing for the company as
compensation and benefit packages, ensuring the safety and overall a whole and is
health of personnel, and providing training and development historical in nature.
opportunities for employees. It can include both
financial and
These decisions require input from all other functional areas. What
nonfinancial
kind of accounting information do human resource managers need?
information.
Human resource decisions, such as hiring new employees, are often
External Customers and Order status, Limited-access
made under budget constraints. Ensuring safe workplaces for suppliers shipping dates, databases
employees may involve the redesign of manufacturing processes. inventory levels, available to
Accountants can provide information regarding the cost of the etc. This specific
redesign. The decision to train employees to use new equipment may information must customers and
require an analysis of the costs and benefits of the new program. be very detailed suppliers
and timely to be
THE INFORMATION NEEDS OF INTERNAL AND EXTERNAL useful
USER Internal Marketing, Timely and detailed Limited-access
The information needs of internal users and external users differ in operations and information on databases
significant ways. Because of the varying needs of internal users, production, sales and expenses, available to
managerial accounting is more flexible than financial accounting. finance and product costs, specific
human budgetary customers and
Although financial accounting is geared toward the preparation of
resource considerations, and suppliers
financial statements and other reports according to generally accepted
managers measure of
accounting principles (GAAP) and other rules, managerial accounting performance. Cost reports,
can be customized to a specific company or segment of a company. Often includes budgets, and
Financial accounting is concerned primarily with reporting on the nonfinancial data other internal
company as a whole, managerial accounting emphasizes the various (direct labor hours, documents.
segment of a company, such as divisions, departments, sales, regions, units to break even,
and product etc.) Accounting
lines. information is
Because of the decision focus of internal managers, managerial frequently needed
accounting information must focus on the future rather than the past. for segments of an
Planning is an integral part of the manager’s job, and in order to plan organization and is
effectively, managers need to up-to-date information. Although the more likely future
oriented than
timeliness of information is paramount, managerial information
historical
frequently is less precise than financial accounting information and
often includes the use of estimates.
The Role of the Managerial Accounting
External and Internal Users of Accounting Information
Managerial Accountants have traditionally been thought of as the
Type of
bean counters or number crunchers in an organization. However,
Accounting
Users Source advances in AIS and other changes in the past decade have resulted in
Information
Needed the automation of traditional accounting functions involving data
External Shareholders Sales, gross profit. Annual collection, data entry, and data reporting and a corresponding shift of
and creditors Net income, cash reports, those functions from management accounting to clerical staff.
flow, assets and financial As a result, managerial accountant in many companies now focus
liabilities, earnings statements, on analysing information and creating knowledge from it rather than
per share, etc. and other collecting data.
Although such available Managerial accountants have become decision-support specialists
information is documents who see them role as interpreting information, putting it into a useful
primarily financial, format for other managers, and facilitating management decision
it may also include making.
nonfinancial
information (units
Relevant Factors and Decision Making
 Although the problems and questions facing marketing, production, Opportunity cost are the benefits forgone by choosing one
finance and human resources managers of organization differ, the alternative over another and are relevant costs for decision-making
decision-making process that they follow is remarkably uniform. In purposes.
fact, it is the same decision-making model that you are likely to use Example: in choosing to go to college, you are forgoing the salary you
when making nonbusiness decisions. Ex. Decision to purchase or sell a could receive by working full time.
car, a computer or a stereo system or decision to attend a particular Almost all alternatives have opportunity costs. In choosing to work
college, accept a summer job or perhaps even get married. instead of going to school, the opportunity cost is the higher salary that
Decision have many variables or factors that must be considered. If you might later earn if you choose to go to school.
you are making a decision to purchase a car, you would consider such Opportunity costs are sometimes difficult to quantify but
as variables such as its costs, features, color and financing options. nevertheless should be considered in making decisions
If you were making decision about what college to attend, factors
might include the cost, proximity to your home, and academic ETHICS AND DECISION MAKING
reputation. Business manager make ethical decisions every day. Although some
Different decision makers might even consider different factor for might argue that business decisions are simply a matter of economics,
the same decision making. For example, the color of the car may be there are also ethical dimensions to most of these decisions.
unimportant to one buyer but critical to another. In business environment today, companies have to be aware not only
The number and type of variables considered might differ for each of the economic impacted of their decisions but also of their ethical
individual and for each decisions that individual makes. impact.
Decisions may have to be made under time, budget or other Ethical problems arise in organizations for a variety of reasons. For
constraints. Many decisions are made with missing information or at example, undue pressure to achieve short-term productivity and
least with imperfect information. Ex. In deciding which car to buy, you profitability goals may lead to unethical behaviour, such as requiring
probably want to consider the cost of future repairs of various model. employees to work long hours that exceed limits set by state and federal
Although you might estimate these cosets by using such sources as agencies, intentionally ignoring product safety concerns, or falsifying
Consumer reports, you will not know the costs with certainty. accounting records or other documentation.
Decisions may not be perfect, but they should be the best you can Such unethical behaviour often occurs in corporate environments in
make given the information that is available to you at the time. The which employees feel that they have no choice but to follow their
process you go through is to gather all the information you can to superior’s orders and directives. Strictly adhering to an organizational
reduce the risk of an incorrect or less-than-optimal decision. hierarchy can be problematic if employees blindly follow orders.
Decision making is the process of identifying different courses of Famous economists Milton Friedman once argued that the only
actions and selecting one appropriate to a given situation. All decision social
requires using judgment and the quality of a decision often depends on responsibility of corporations was to increase their profits. Further, he
how good that judgement is. state that business managers should not be expected to make socially
Judgements refers to the cognitive aspects of the decision-making responsible decisions because they are not trained to do so.
process. By cognitive, we mean taking a logical, rational approach to Given the world in which we now live, this perspective may no
making decisions rather than making decisions impulsively on the spur longer be valid. Managers simply cannot make business decisions
of the moment without carefully considering their ethical dimensions. How managers
can use information for both good and bad ends. Doing so will increase
RELEVANT COST the likelihood that you will be prepared to make informed and ethical
What should you consider in making decision? An effective choices as a business manager.
approach is to focus on factors that affect a particular decision. That is Business ethics results from the interaction of personal morals and
relevant factors are those which differ among alternatives. For the processes and objectives of business. Business ethics is nothing
example, if you were deciding which automobile to purchase and each more than our personal views of right and wrong applied in a business
automobile you were considering had the same options at the same cost setting.
(air-conditioning), you would conclude that those options are not For example: Business practices that are viewed as unethical such
relevant to the decision because they do not differ among the various as: (1) managers lying to employees, (2) stealing from a company, (3)
automobiles. Very often, cost is the key factors that must be considered divulging confidential information, and (4) taking credit for the work of
in decisions. others.
Relevant cost are those which differ alternatives. Another way to view Consider how these unethical business practices could occur in
relevant costs is to identify those which are avoidable, or those which your personal life. For example: (1) a child may lie to her mother, (2) a
can be eliminated by choosing one alternative over the another. roommate may steal money from you while you are in class, (3) a
friend may tell another person about a private conversation that you and
SUNK COST he had, and (4) a group member may contribute nothing to a group
Sunk cost are costs that have already been incurred. Because sunk costs project yet accept full credit for the project.
cannot be avoided, they are not relevant in a decision. Business ethics is, in many ways, an extension of our personal
Example: in your decision to trade in your old vehicle, the amount that ethics. Of course, the stakes are often much higher, or at least very
you paid for it may appear to be important. However, because that cost different. Consider the many billions of pesos that the tobacco industry
is sunk, it cannot be avoided, is not relevant and should not be paid in damages because its members lied to consumers and the
considered in your decision. government about the harmful effects of nicotine.
If sunk cost are not relevant, what about costs that will incurred in the In addition, manager must consider various stakeholders when
future? Are all costs that are not sunk relevant? Again, the key is that evaluating ethical dilemmas. A chief executive officer cannot simply
relevant costs are avoidable costs. If future costs do not differ among make the decision that is best for her without considering the interests
alternatives, they are not avoidable and therefore not relevant. of others employees, stakeholders, customers, suppliers, creditors, and
so forth.
OPPORTUNITY COST Integrity is the cornerstone of ethical business practices. Failure to
build a business on integrity carries costs. For example: a deceptive
business practices may harm a company’s standing in the community,
decrease employee productivity, reduce customer loyalty, build
resentment among employees, increase the likelihood of further ELEMENTS OF PRODUCTION DECISION
unethical behaviour by employees, and cause scrutiny by government  Amount to produce
agencies. Although the costs of some of these consequences are difficult  Whether to move forward with mass production
to quantify, there is no doubt that they can be substantial  Technology to use
 Input combinations to use
ETHICS PROGRAMS
Companies frequently create ethics programs to establish and help TYPES OF PRODUCTION PROCESS
maintain an ethical business environment. Some of the most common 1. JOB PRODUCTION OR JOBBING - consists of an operator or
elements of ethics programs are written code of conduct, employees hot group of operators to work on a single job and complete it before
lines and ethics call centers, ethics training, processes to register proceeding to the next similar or different job.
anonymous complaints about wrongdoing, and ethics offices. 2. BATCH PRODUCTION - is a method whereby a group of
identical products are produced simultaneously (rather than one at
PRODUCT COSTING: Manufacturing process, Cost terminology a time)
and Cost Flows 3. MASS PRODUCTION - the manufacturing of large quantities of
standardized products, often using assembly lines or automation
Every company provides a product or service to customers and technology. Mass production facilitates the efficient production of
clients. Manufacturing companies like Toyota and Dell Computers a large number of similar products.
take raw materials and produce new products from them. 4. SERVICE PRODUCTION - is the process of delivering services
to customer
CHAPTER 2 5. CUSTOMIZED PRODUCTION- production and direct only
Merchandising companies sells products that someone else has against specific orders from customers.
manufactured. Examples: (large department stores, independent music
shop or clothing store on the corner. MANUFACTURING IN A TRADITIONAL ENVIRONMENT
Service companies do not sell a tangible product as their primary Manufacturing is the process of converting raw materials or parts
business. into finished goods through the use of tools, human labor, machinery,
Service provider include such diverse companies and industries as and chemical processing . Before the Industrial Revolution, most
airlines, hospitals, automobile repair shops, brokerage firms, law firms, products were handmade using human labor and basic tools . However,
and CPA firms. Service providers are the fastest-growing segment of the Industrial Revolution led to mass production, assembly line
the economy, employing roughly 75 percent of workforce . manufacturing, and the use of mechanization to manufacture larger
Regardless of the type of company involved, costs are associated quantities of goods at a lower cost
with the products and services produced and sold.
Example: Preparing financial statement for bank use in determine TRADITIONAL
whether to make a loan or may be filing its income tax  use of basic tools and human labor to produce goods
Generally accepted accounting principles (GAAP) and tax laws  manufacturing processes rely on human labor
govern costing for financial statement purpose and for tax purposes,  often limited in their ability to produce customized products due to
respectively. the need for specific tools
In contrast, a company might want to determine the cost of the
particular product in order to determine its sales price or to estimate a MODERN ENVIRONMENT
product’s profitability.  use of advanced technology
Cost information is also helpful for budgeting and evaluation  manufacturing processes rely on advanced technology such as
process. robotics and automation
 more flexible and can produce a wider range of customized
THE PRODUCTION PROCESS products due to the use of computer-aided design (CAD) software
Is the methods of using economic resources or inputs such as
natural resources, labor, or capital equipment to create goods or Traditionally, the factory of a manufacturing company was
services or outputs that have value or utility for consumers. organized with similar machines grouped together.
Manufacturing companies purchase raw materials from other For example: a furniture manufacturer still using traditional
companies and transform them into a finished product. This process such cutting and rough sanding, shaping the cut lumber into
transformation typically requires labor and the incurring of other costs furniture pieces, using lathes and routers, drilling holes and dovetailing
such as the cost of utilities, the depreciation of factory equipment, and joints, assembling the furniture pieces, and finishing.
the cost of supplies. In traditional system, it was normal to accumulate raw materials
Manufacturing companies may produce a single product or many inventory and finished-goods inventory to serve as buffers in case of
products. Likewise, companies may have only a few customers or unexpected demand for products or unexpected problems in production.
many thousands.
The process used to manufacture these products depends on the RAW MATERIALS INVENTORY - inventory of materials needed
specific product or products made, the customer who buy the product(s) in the production process but not yet moved to the production area.
and the company itself. TYPES OF RAW MATERIALS
Some companies are very labor intensive, whereas others rely  MINED BASED
heavily on automation.  PLANT BASED
Some companies choose to make very high quality products,  ANIMAL BASED
whereas other companies emphasize low cost. FINISHED-GOODS INVENTORY - inventory of finished product
Some companies choose to carry large amounts of inventory, waiting for sale and shipment to customers.
whereas others manufacture their products in small batches and make
them just in time to meet customer demand. HOW DOES IT AFFECT IN THE FINANCIAL STATEMENT
Finished goods inventory is a crucial component of a company’s delivered to the customer, rather than resisting changes that
financial statements. It is included in the current assets section of a improve the process of creating and delivering customer
company’s balance sheet. 4. Pull. The degree to which the value stream is only processing
products and services for which there is a customer demand, rather
It is normal to accumulate inventories of partially completed than creating something and hoping someone wants it.
products called work-in process inventory, or WIP. 5. Value. it is determined by what the customer considers to be
WIP might result, for example for furniture pieces that have been important within a product or service, rather than what the
drilled and jointed are pushed to the assembly area before the workers individuals developing or delivering the product or service
in that area are ready for them. consider important.
WORK-IN PROCESS inventory - inventory of unfinished
products (in other words, what is left in the factory at the end of the The Japanese word of waste is “MUDA” which is focus of much
period) attention all over the world. Who knows better than production
To calculate WIP inventory, you can use the following formula: employee – who spends 8 hours a day on a job – how to reduce waste?
The goal is to tap this resource by giving production employees the best
WIP Inventory = Beginning WIP Inventory + Manufacturing Costs - tools available.
Cost of Goods Manufactured MUDA (waste) is defined as any expense that does not help produce
value.
Where:
 Beginning WIP Inventory: The value of work in process inventory EIGHT KINDS OF MUDA
at the beginning of an accounting period. 1. Overproduction
 Manufacturing Costs: The sum of direct materials, direct labor, When components are produced before they are required by the next
and manufacturing overhead costs incurred during the accounting downstream process, overproduction occurs. This has several negative
period. effects. It creates a “caterpillar” effect in the production flow and
 Cost of Goods Manufactured: The total cost of goods completed results in the creation of excess WIP This leads to staging and therefore
during the accounting period labor required to move the WIP additional times. And it can hide
defects that could have been caught with less scrap if processes were
LEAN PRODUCTION AND MANUFACTURING IN A JIT balanced to allow detection earlier as earlier use of the WIP
ENVIRONMENT components would have revealed the defect in time to correct the issue.
One of the big changes affecting companies in the past 20 to 25 Common causes of Overproduction include:
years has been the adoption of lean production system and just-in-time  Unreliable process
(JIT) manufacturing.  Unstable production schedules
In an effort to reduce costs and increase efficiency, companies began  Inaccurate forecast and demand information
to focus on the costs and problems associated with the traditional  Customer needs are not clear
manufacturing facility and the practice of carrying large amounts of  Poor automation
inventory.  Long or delayed set-up times
LEAN PRODUCTION is focused on eliminating waste associated 2. WAITING
with holding more inventory than is required, making more product Waiting can include people, material equipment (prior runs not
than is needed, overprocessing a product, moving products and people finished) or idle equipment (mechanical downtime or excess
farther than is required, and experiencing downtime caused by people changeover time). All waiting costs a company has in terms of direct
waiting for work to do and products waiting in mid-assembly labor dollars and additional overhead costs can be incurred in terms of
One of the key aspects of lean production is managing inventory. overtime, expediting costs and parts. Waiting may also trigger
Carrying large amounts of inventory results in storage and additional waste in the form of defects if the waiting triggers a flurry of
insurance costs. activity to “catch up” that results in standard work not being followed
Traditional manufacturing systems may result in other, not-so- or shortcuts being taken.
obvious problems, including the production of lower quality products Common causes of Waiting include:
with more defects.  Unplanned downtime or Idle equipment
The buffers that seem so desirable may in fact lead workers to pay  Long or delayed set-up times
less attention to detail and work less efficiently.  Poor process communication
The organization of factories in which similar machines are grouped  Lack of process control
together greatly increases the time necessary to manufacture products  Producing to a forecast
and makes it more difficult to meet special orders or unexpected  Idle equipment
increases in demand without having large amounts of inventory on 3. TRANSPORTATION
hand. Poor plant design can cause waste in transportation. It can also trigger
other wastes such as waiting or motion and impact overhead costs such
as higher fuel and energy costs and higher overhead labor in the form of
FIVE PRINCIPLES OF LEAN MANUFACTURING lift drivers as well as adding wear and tear on equipment. It may also
1. Value Stream. The set of business activities and steps involved in result from poorly designed processes or processes that have not been
creating and delivering products and services to the customer; it is changed or updated as often as required.
the connection of the steps together rather than considering each Common types of Transportation Waste:
step in isolation  Poor layouts – large distance between operations
2. Flow. The degree to which there is smooth uninterrupted flow of  Long material handling systems
activities that add value to the customer, rather than waste and  Large Batch sizes
inefficiency that impedes the flow through the value stream  Multiple storage facilities
3. Perfection. The continuous assessment of value stream  Poorly design production systems
performance to identify and improve the value created and 4. EXCESS PROCESSING
Excess processing is a sign of a poorly designed process. This could be  Poor management
related to management or administrative issues such as lack of  Lack of team training
communication, duplication of data, overlapping areas of authority and
human error. It may also be the result of equipment design, inadequate JUST-IN-TIME (JIT) MANUFACTURING
job station tooling or facility layout. Is the philosophy of having raw materials arrive just-in-time to be
Examples of Excess Processing include: used in production and for finished-goods inventory to be completed
 Poor communication just in time to be shipped to customers.
 Not understanding your customers’ needs In a just-in-time system, materials are purchased and products are
 Human error made “just-in-time” to meet customer demand.
 Slow approval process or excessive reporting Unlike traditional production, the process begins with the customer
5. INVENTORY order, and products are “pulled” through the manufacturing process.
Inventory is considered a form of waste because of the related holding Unlike ideal conditions, companies operating in a JIT environment
costs. This is true of raw materials, WIP and finished goods. Over would reduce inventories of raw materials, work in process, and
purchasing or poor forecasting and planning can lead to inventory finished goods to very low levels or even zero.
waste. It may also signal a broken or poorly designed process link With only a small buffer of extra finished goods and raw materials, it
between manufacturing and purchasing/scheduling. Lean is imperative that companies employing JIT be able to procure supplies
Manufacturing does not just focus on the factory but also requires and raw materials on a timely basis. This requires that companies
process optimization and communication between support functions. work with suppliers that can deliver goods on time and free of defects.
Common causes of Inventory Waste include: In order to successfully implement lean production and JIT
 Overproduction of goods manufacturing systems, companies must be able to manufacture
 Delays in production or ‘waste of waiting’ products very quickly. This often entails restructuring the factory itself.
 Inventory defects In traditional factory, similar machines were often grouped together,
 Excessive transportation resulting in raw materials and unfinished products being handled and
6. MOTION moved a great deal from area to area. It also difficult and time
Motion costs money. This not only includes raw materials but also consuming to switch production from one product to another.
people and equipment. It may also include excess physical motion such In contrast, factories in a JIT environment are typically organized so
as reaching, lifting and bending. All unnecessary motion results in non- that all the machinery and equipment needed to make a product is
value-added time and increases cost. available in one area.
Again, referencing core Lean Manufacturing methodology, process These groupings of machines are called manufacturing cells.
mapping should include facility layout and optimized workplace design The use of cells minimizes the handling and moving of products. It
that includes analysis of the distance of motion within the space as well also reduces or eliminates setup time.
as the location of parts, supplies and tools within the space as well. Sometimes, workers are trained to operate all the machinery in a
Common Motion Waste examples include: manufacturing cell, increasing speed and efficiency even more.
 Poor workstation layout Although it is easy to think of lean production and JIT as inventory
 Poor production planning management tools only, successful implementation provides an array of
 Poor process design benefits including the following:
 Shared equipment and machines 1. Reduced waste and scrap
 Siloed operations 2. Improved product quality
 Lack of production standards 3. Lower overall products costs
7. REWORK 4. Lower labor costs
Defects impact time, money, resources and customer satisfaction. 5. Reduced inventory
Examples of Defects within a manufacturing environment include lack 6. Reduced processing time
of proper documentation or standards, large variances in inventory, poor 7. Increased manufacturing flexibility
design and related design documentation changes and an overall lack of However, disruptions in supply can wreak havoc on companies that
proper quality control throughout the process workflow. rely on just-in-time purchasing of parts and supplies. These disruptions
Specific Defect causes include: may result from strikes by factory workers of the suppliers, natural
 Poor quality control at the production level disasters, or the unexpected closing of national borders (when suppliers
 Poor machine repair are located in other countries).
 Lack of proper documentation For example: Terrorist attacks on the World Trade Center on
 Lack of process standards September 11, 2001.
 Not understanding your customers’ needs
 Inaccurate inventory levels PRODUCT COSTS IN MANUFACTURING COMPANY
8. POOR PEOPLE UTILIZATION Regardless of the size of the company involved, the number of
Non-Utilized Talent products made, or the type of manufacturing system used,
The eighth waste is the only lean manufacturing waste that is not manufacturing companies must know how much their product cost.
manufacturing-process specific. This type of manufacturing waste It is useful to distinguish between direct and indirect costs.
occurs when management in a manufacturing environment fails to Direct costs - are costs that are directly attached to the finished product
ensure that all their potential employee talent is being utilized. This and can be conveniently traced to that product.
waste was added to allow organizations to include the development of Indirect costs - are costs that are attached to the products but cannot be
staff into the lean ecosystem. As a waste, it may result in assigning conveniently traced to each separate product.
employees the wrong tasks. Manufacturing costs - these costs incurred in the manufacture of a
Examples of Non-Utilized Talent: product from nonmanufacturing costs (costs incurred elsewhere in the
 Poor communication company). Manufacturing costs typically consist of three components:
 Failure to involve people in workplace design and dev. direct materials, direct labor, and manufacturing overhead.
 Lack of or inappropriate policies
 Incomplete measures DIRECT MATERIALS
 Are defined as materials that can be directly and conveniently traced Although nonmanufacturing costs are necessarily incurred in
to a particular product or other cost object and that become an integral running a business, they are not directly incurred in the production of
part of the finished product. products.
Direct materials typically cause few problems in the costing of Common examples of nonmanufacturing costs include advertising
products. The amount of direct materials used in making product can costs, commission paid to salespersons, administrative and accounting
usually accurately measured by engineering studies, and the accounting salaries, and the cost of office supplies.
systems of most companies are capable of tracing the materials used Nonmanufacturing costs also include rent, insurance, taxes, the
and the costs of those materials to specific products. However, cost of utilities and depreciation of equipment when used in selling and
questions do arise, and judgment is often needed to correctly classify administrative activities.
materials as direct or indirect. NONMANUFACTURING COSTS are called PERIOD COSTS.
Example: Ford Motor Company (sheet metal and tires are direct
materials) Exhibit 2.2 - Manufacturing and Nonmanufacturing Costs

DIRECT LABOR
Is the labor cost (including fringe benefits) of all production
employees who work directly on the product being made or service
being provided. Sometimes, direct labor is called touch labor to reflect
the hands-on relationship between the employee and the product or
service.
Assembly line workers are the clearest example of direct labor. as
with direct materials, the identification of direct labor cost is usually
straightforward and accurate.
Time sheets may be used to keep track of the work employees
perform on different products and the wages they are paid.
COST FLOWS IN A MANUFACTURING COMPANY-
MANUFACTURING OVERHEAD TRADITIONAL ENVIRONMENT WITH INVENTORY
All costs incurred in the factory that are not properly classified as If companies simply used all the materials they purchased to make
direct materials or direct labor are called manufacturing overhead. one product, finished making all the units of that product that they
Manufacturing overhead includes both indirect materials and started, and sold everything they finished, then calculating the income
indirect labor. or less from selling the product would be relatively easy.
Materials that we know are used in the manufacture of products However, when multiple products are made or when materials are
but cannot be measured with reasonable accuracy and easily and not all used, goods are not all finished, or products are not all sold, the
conveniently traded to a particular product are called indirect materials. process becomes difficult.
To accurately determine the cost of manufactured products, a
Example: screws and glue used by a furniture manufacturer is company must trace or allocate manufacturing costs to each individual
classified as indirect materials. product as it is being produced and then follow those costs through
various inventory accounts as the product progress toward eventual
Certain labor costs that are not directly associated with production completion and sale.
are classified as indirect labor and included in manufacturing overhead. At the point of sale, the cost of producing product (the cost of
Example: labor costs of janitorial staff and maintenance workers in a goods sold) must be matched with the sales price to compute a profit or
factory and supervisor who do not directly work on a product. loss on the sale (called gross margin or gross profit)
Subtracting nonmanufacturing costs from the gross margin
Manufacturing overhead also include utilities, depreciation of provides a measure of profitability for the company as a whole.
factory equipment and buildings, rent, repairs and maintenance, When materials are not all used in products, goods are not
insurance and other factory cost. finished, or finished goods are not all sold, costs must be accounted for
In a traditional manufacturing environment, the costs included in in the appropriate raw materials, work in process, or finished goods
manufacturing overhead are most often indirect in nature and cannot be inventory accounts.
conveniently and accurately traced and assigned to a specific product. Manufacturing costs include the cost of direct materials, direct
Remember, the machinery and equipment are typically used to labor and manufacturing overhead. These costs are called product costs
make multiple products, making it difficult to trace the cost of a because they attach to the product as it goes through the production
machine to a specific product. process.
Although many overhead costs in a JIT environment will also be Exhibit 2.3 - Overview of Cost Flows in Manufacturing Company
indirect in nature (example rent and utilities), more of the costs are
likely to be direct in nature.
Manufacturing costs are also called product costs or inventoriable
costs because they attach to products as they go through the
manufacturing process. Direct material, direct labor, and overhead
costs remain with the product until it is sold.
Only when the product is sold are these costs expensed on the
income statement as cost of goods sold.

NONMANUFACTURING COSTS
Consists of those costs which are incurred outside the plan or
THE COST-OF-GOODS SOLD MODEL FOR A TRADITIONAL
factory and typically are categorized as selling and administrative costs.
MANUFACTURING COMPANY WITH INVENTORY
 To illustrate the production process and some of the association
problems with costing products, we will use a fictional company called
Northern Lights Custom Cabinets which manufactures and sells
custom-ordered kitchen and bathroom cabinets.
The company sells primarily to building contractors but
occasionally deals directly with homeowners. The company has been
in the business only a few years, so management is still learning the
business and how to properly determine the cost of each cabinet.

The Northern Lights has an engineering and design division,

which is involved in all custom-cabinet jobs. Quality control dictates
that the engineering and design division must design all cabinets. The Therefore, the work-in-process is 45,000
company strives to minimize the cost of productions without sacrificing
the quality. Once the design phase of each cabinet job is complete, the The journal entry to record the transfer of raw materials from raw
materials must be ordered. The material is stored in the raw materials materials inventory to WIP inventory is as follows:
warehouse until needed for the job and is then moved to the production Work in Process Inventory 45,000
area. Raw materials inventory
The production company is separated into three distict areas: 45,000
cutting, assembly, and finishing.
Exhibit 2.4 - The Northern LIghts Production Process As direct labor costs of 65,000 are incurred (factory workers work
on the cabinets), the cost of the workers is added to the raw material
cost in the WIP inventory account, Likewise , as manufacturing
overhead costs of 85,000 (machine costs, rent, depreciation, the cost of
utilities, the cost of indirect materials) are incurred, they are added to
the WIP account. As long as each set of cabinets remains in the factory,
the costs associated with them are recorded in the WIP account.

The journal entry to record the incurrence of direct labor costs:

Work in process inventory 65,000
Salaries and Wages Payable (or Cash) 65,000
Northern LIghts purchase raw materials and stores the materials in
The journal entry of manufacturing overhead costs:
a warehouse that is separate from the production facility, or factory.
Work in process Inventory 85,000
While these materials are in the warehouse, the costs of the raw
Accounts Payable (or Cash) 85,000
materials are included in a raw materials inventory account.
Note: That the actual manufacturing overhead costs are incurred, they
The Purchase of Raw Materials
are entered directly into the WIP account, with corresponding credits to
accounts payable to cash. This system of product costing using actual
overhead costs incurred is called actual costing

ACTUAL COSTING - a product costing system in which actual

overhead costs are entered directly into the work in process

NORMAL COSTING - a product costing system in which estimated

or predetermined overhead rates are used to apply overhead to work in
process.
The journal entry to record the purchase of raw materials is as
follows:
THE CALCULATION OF COST OF GOODS MANUFACTURED
Raw materials inventory 40,000
Accounts Payable (or Cash) 40,000

When raw materials are moved to the factory, the raw materials
costs move with the material at a work in process (WIP). Any raw
materials not used during the year remain in the raw materials inventory
account.

Transferring Raw Materials to Work In process

Therefore:
The cost of goods (cabinets) manufactured is transferred to finished
goods
The journal entries to record the transfer of finished goods from
WIP to finished goods inventory is as follows;
Finished goods 190,000
Work-in-process inventory 190,000

When the cabinet is sold, the accumulated costs in the finished-

goods inventory account are moved to the cost-of-goods-sold account.
If there is no beginning inventory of finished goods, and all the
goods finished in the current year are sold, the cost of goods sold is
INCOME STATEMENT FOR A MANUFACTURING COMPANY
equal to the cost of goods manufactured.
However, when beginning and ending inventories exist, the cost of
goods sold must adjusted accordingly.

Example:
Northern Lights had one order costing of 30,000 that was not delivered
to customers by the end of 2019. Likewise, at the end of 2020, the
company had 5,000 of cabinets that were finished but not sold.
Therefore, the cost of goods (cabinets) sold during 2020 was 215,000.

THE CALCULATION OF COST OF GOODS SOLD

COST FLOWS IN MANUFACTURING COMPANY - JIT

ENVIRONMENT
How do cost flows differ in manufacturing company utilizing JIT?
In JIT environment, the physical flow of goods is streamlined by the
use of manufacturing cells that largely eliminate inventories of raw
materials, WIP, and finished goods.
Cost flows are streamlined as well. Direct materials, direct labor,
and overhead costs can essentially be accumulated directly in a cost-of-
goods-sold account.
The journal entry to record the cost of goods sold and the transfer
Because raw materials are immediately put into production when
goods out of finished-goods inventories as the product sold is as
purchased, there is no need to record their purchase in a separate raw
follows;
materials inventory account.
Cost of goods sold 215,000
Likewise, because all goods are typically finished and shipped out
Finished-goods Inventory 215,000
immediately to customers, there is no reason to keep track of WIP or
finished goods inventories
COST FLOWS IN MANUFACTURING
CALCULATION OF COST-OF-GOODS SOLD - JIT
ENVIRONMENT

Schedule of Cost of Goods Manufactured and Schedule of Cost of

Goods Sold for a Manufacturing Company
MERCHANDISING COMPANIES AND THE COST OF
PRODUCTS
Wholesalers and retailers purchase merchandise in finished form
from other companies. With the exception of packaging and other
minor changes, they simply offer the products for resale or other
companies (wholesalers) or to the ultimate consumer (retailers).
Therefore, the product cost of a wholesaler or retailer sells.
Because merchandising companies simply purchase goods for
resale, the flow of costs in a retail or whole establishment is fairly
simple.
On the balance sheet, merchandising companies use a single
account for inventory called merchandise inventory. The costs
incurred in inventory are simply the costs to purchase inventory.

HOW ARE THE COSTS INCURRED IN PURCHASING

INVENTORY FOR RESALE EXPENSED?
 From the financial accounting that the principle of matching
revenue from sales with the costs associated with that revenue means FOR EXAMPLE:
that the cost of purchasing merchandise is expensed as cost of goods 1. In the movie studio, costumes and props are direct materials and
sold as the merchandise is sold. the salaries of actors and directors are direct labor. Overhead
However, the cost of goods sold is not necessarily equal to the cost would include the costs of studio itself and the recording and
of merchandise purchased during the period. production equipment. Camera operators and other support people
If merchandise is purchased and not sold or if merchandise that would more than likely classified as indirect labor because they
was purchased in another period is sold in the current period, cost of would probably work on more than one film at a time.
goods sold must be adjusted accordingly. 2. CPA FIRM, material costs would be very small. Although paper
and other materials are used in the preparation of tax returns, the
Example materials would be probably considered an indirect cost and
Cheryl’s Bike Shop begins 2019 with a beginning inventory of bikes classified as overhead.
and parts of 15,000. During the year, the company purchases 63,000 of Although service companies typically have little need for raw
merchandise and has 78,000 of merchandise available for sale. At the materials accounts and finished goods inventory accounts, work in
end 2019, 18,000 of merchandise inventory remains on hand, resulting process (WIP) accounts are commonly used on projects that were
in 60,000 of cost of goods sold. incomplete at month’s end such as audits of CPA firm, lengthy legal
cases by law firms, and consulting engagements that are long term.
Schedule of Cost of Goods Sold for a Merchandising Company
PRODUCT COSTS AND PERIOD COSTS
Manufacturing costs or product costs are attach to products as
they go through the manufacturing process until the sale of the
products, the cost of manufacturing are included in one of three
inventory accounts: raw materials, work in process and finished goods.
These inventory accounts appear on the balance sheet along with other
assets and liabilities only when a product is sold are manufacturing
costs expense as ost of goods sold on the income statement.

The Calculation of Cost of Goods Sold for a Merchandising THE PATH TO THE INCOME STATEMENT --PRODUCT AND
Company PERIOD COSTS

COST CLASSIFICATION
With the sales of 175,000 and selling and administrative expenses
totalling 40,000, the income statement as follows:

 Manufacturing cost - is cost incurred in the production of the

product or service. It composed of three elements: direct material,
SERVICE COMPANIES AND THE COST OF SERVICES direct labor and manufacturing overhead. Direct material plus
Many similarities exist between the cost of products in direct labor are called PRIME COST. Direct labor plus
manufacturing company and the costing of services. manufacturing overhead are called CONVERSION COST.
Service provider must calculate must calculate the costs Manufacturing overhead includes indirect materials, indirect labor
associated with the revenue earned by the company from selling its and other factory burdens.
services.  Nonmanufacturing cost - is cost incurred in administering the
Income statement of service providers typically refer to the “cost operation of the business and commercializing the product or
of services” as the “cost of revenue”. LIke product costs, the cost of service of the company. It is commonly called operating expenses
services includes three components: direct materials, direct labor and which are charged to revenues for the period
overhead. However, the proportion of each may vary drastically.  Product cost - is a cost assigned to goods or services until sold.
Service companies typically have a small amount of material costs It is also known as inventoriable cost, since the product is stored as
and large amount of labor and overhead. inventory until sold.
 Period cost - is the cost that is matched against revenues in the c. Mining-based - minerals, metals, crude oil, coal etc.
time period in which it is incurred. This cost is not included as
part of the cost of goods purchased for sale (in merchandising B. WORK-IN PROCESS INVENTORY - refers to partially
concern) nor goods to be manufactured (in manufacturing completed materials within a production cycle. It includes raw materials
concern). These costs are the normal operating expenses such as and cost of developing these materials into a final product
selling, administrative and general expenses of the firm. These C. FINISHED GOODS INVENTORY - number of manufactured
costs are identified with the period of time in which they are products in stock that are available for customers to purchase
incurred and are recognized as expenses. D. MERCHANDISE INVENTORY - is an account on a balance
 Statement of Financial Position - IT PRESENTS A sheet that reflects the total amount paid for products that are to be sold.
COMPANY’S “POSITION” WHEN IT COMES TO THE
RESOURCES IT OWNS (ASSETS), OBLIGATIONS CLAIMED COST CLASSIFIED AS TO TRACEABILITY OF COST
AGAINST IT (LIABILITIES) AND THE OWNER’S RESIDUAL OBJECTIVE
INTEREST OR THE INVESTMENT OF ITS OWNERS
(EQUITY/PROPRIETORSHIP). The inventory cost is the DIRECT COST – is a cost that can be traced to a particular plant or
percentage of inventory values. It includes the price a company department. It is obviously or physically traced to the particular
pays to buy, store, and maintain items segment under consideration.
The types of inventory cost are a) ordering cost; b) carrying cost; For example, if the segment under consideration is a production
and c) shortage or stock out cost and cost of replenishment department which produces different products, materials and direct
Income Statement - or statement of profit or loss or labor is a direct cost of every product line as well as that production
statement of financial performance summarizes the results of department. The salary of the production department head is equally a
business operation for a period of time (cost of sales and direct cost as far as the production department is concern but an indirect
other operating expenses) cost as far as the different product lines are concern. This is because
the production supervisor is in-charge of all the product lines being
produced, and it is difficult to specifically trace his salary cost to those
products. Thus, allocation is necessary as most of the factory overhead
costs are being allocated using any applicable methods of allocation.

INDIRECT COST - is a cost that is not directly traceable to a

particular department or sub-unit. The salary of the production
supervisor needs to be allocated to the product lines as this is classified
as indirect cost with respect to the product lines, but direct as to
production department. But for example, the depreciation expense of
the entire building where both office and production are located is an
indirect cost of the production department and an indirect cost also of
the product lines.
COST CLASSIFIED IN RELATION TO ORGANIZATION’S
ACTIVITY AND ITS BEHAVIOR COST CLASSIFIED AS TO MARGINAL INFLUENCE OR AS
 COST BEHAVIOR – means how a cost will react or respond to TO CONTROLLABILITY
changes in the level of company’s activity. ACTIVITY refers to a  CONTROLLABLE COST – is a cost that the manager can
measure of the organization’s output of products or services. significantly or heavily influence the level of incurrence of such
The manager must be able to predict or anticipate which will cost cost. A cost is considered to be “controllable” if the manager has
will be change and which are not and up to what extend. The manager the power to authorize the incurrence of such cost. The manager
must also identify the cost driver to which the changes of cost is can decide the price, quantity, quality and from whom they are
associated. COST DRIVER is the activity that cause costs to change or going to buy the materials or services his department needs.
activity that incur costs. These costs are:  UNCONTROLLABLE COST – is a cost that the manager
 VARIABLE COST – is a cost that changes, in total, directly cannot significantly influence its incurrence. Normally, these are
proportional to the changes in the level of activity (or cost driver). costs that are allocated to his department by the higher authority.
 FIXED COST - is a cost that remains unchanged, in total as the But in most cases too, these are direct costs incurred by his area
level of activity (or cost driver) varies within the relevant range but decisions to incur such costs are made by higher authority
 SEMIVARIABLE COST – OR MIXED COST – is cost
composed of fixed and variable behavior or nature. Mixed cost is
always present in all organizations however, management always
assumes that mixed cost has been segregated using the different
cost segregation technique. Mixed cost cannot managed unless the
fixed portion and variable portion were identified.

COST CLASSIFIED IN TYPES OF INVENTORY

A. RAW MATERIALS INVENTORY - refers to the total cost of all
the components used to manufacture a product.
- Cost of all raw materials and production supplies that have
been purchased but not yet used at the end of the period.
COST CLASSIFIED AS TO PLANNING AND CONTROL
Types of Raw Materials
a. Plant-based - vegetables, fruits, flowers, wood, latex  STANDARD COST – a predetermined costs estimate that should
b. Animal-based – leather, meat, bones, milk, wool, silk be attained usually expressed in terms of costs per unit. It is an
 estimate expense that normally occurs during the production of a  SUNK COST - is a cost that has been paid or incurred. It is cost
product or performance of a service. that already incurred regardless of the outcome of the current
 BUDGETED COST - is an estimate of the expenses that a decision. Consequently, they do not affect future costs and cannot
company expects to spend going ahead. It used to represent the be changed by any current or future action, such as historical costs
expected/planned cost for a given period. or future committed costs. Though committed costs will be
 ABSORPTION COSTING / FULL COSTING – a costing incurred in the future, it is considered a sunk costs as management
method that includes all manufacturing costs. It is also called is already committed to such costs and a decision not to incur such
“Full Cost Method”. may be more costly.
 DIRECT COSTING/VARIABLE COSTING – is a  OPPORTUNITY COST - it is the benefit sacrifice when the
methodology that assigns to inventory that all overhead costs are choice or one action precludes taking an alternative course of
charged to expense in period incurred, while direct materials and action. In other words, there are benefits forgone in choosing one
variable overhead costs are assigned to inventory. alternative over the other competing alternative. Opportunity cost
 INFORMATION COSTS –cost obtaining information. These are is not usually entered on the books of an organization, but it is cost
Expenditure of time and money that are required to obtain that must be explicitly considered in every decision a manager
information makes.
a. Purchase - purchase price of information such as cost of book a. IMPLICIT COSTS - costs associated with the use of firm’s
or research report own resources and reflect the fact that these resources can be
b. Search - cost of location information employed elsewhere
c. Communication - time required to communicate or stay-up- b. EXPLICIT COSTS - arise from the transaction in which the
date on communicated messages firm purchases inputs or the services inputs from other
d. Analysis - time and expertise required to analyze information. parties.
e. Automation - cost of tools that automate data processing and  MARGINAL COST - It is an extra cost incurred when one
analysis additional unit is produced. Marginal costs typically differ across
f. Development – cost of development new information using different ranges of production quantities because the efficiency of
techniques such as research and experimentation production process changes. This could be determined the
g. Travel - cost of physical travel that may be required to obtain quantity that would be most efficient to produce.
certain types of information.  VALUE ADDED COST – cost that add value to the product.
 ORDERING COST – costs that increase with the number of These costs are result from activities that are necessary to satisfy
orders placed for inventory. It set up costs or essential costs the requirement of the consumer.
incurred every time you place an order from your supplier.  DIFFERENTIAL COST - it is the amount of which the cost
 OUT-OF-POCKET COST - it is a cost that requires the payment differs under two alternative actions. This is also known as
of cash or other assets in the future as a result of their incurrence incremental costs. Although technically, incremental cost would
mean only to increase in cost from one alternative to another;
COST CLASSIFIED AS TO TIME FRAME/COMMITMENT TO decreases in cost should be referred to as decremental cost.
COST EXPENDITURE Differential cost is a broader term, encompassing both cost
 COMMITTED COST - cost that is inevitable consequence of a increases and cost decreases between alternatives. This could be
previous commitment. It is an investment that a business entity compared to the marginal cost concept of the economists.
has already make and cannot recover by any means.  AVERAGE COST PER UNIT – it is the result if the total cost to
 DISCRETIONARY COST – it is a cost or capital expenditure produce the products is divided by the number of units
that can be reduced or eliminated in a short-term without having manufactured or produced.
an immediate impact on the short-term probability of a business.

COST CLASSIFIED AS TO PERIOD OF INCURRENCE

 HISTORICAL COST - cost that were incurred in the past period.
It is what your company paid for an asset when you originally
brought it.
 FUTURE COST - budgeted cost that are expected to be incurred
in a future period. It is also called the survivor cost that arise
during the life years that would not been lived without
intervention. Example: Restoration planning

COST CLASSIFIED AS TO RELATION TO DECISION

MAKING AND OTHER ANALYTICAL PURPOSES
 RELEVANT COST - it is a cost incurred in both alternatives but
will not be incurred in another alternative. As costs incurred in
both alternative such costs would be irrelevant in making a
decision.