Kinney CH 02
Kinney CH 02
Kinney CH 02
Learning Objectives
After reading and studying Chapter 2, you should be able to answer the following questions:
1. Why are costs associated with a cost object?
2. What assumptions do accountants make about cost behavior, and why are these assumptions
necessary?
3. How are costs classified on the financial statements, and why are such classifications useful?
4. How does the conversion process occur in manufacturing and service companies?
5. What are the product cost categories, and what items comprise those categories?
6. How and why does overhead need to be allocated to products?
7. How is cost of goods manufactured calculated and used in preparing an income statement?
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Terminology
Actual cost system: A costing system that charges Work in Process Inventory with the actual direct
material, direct labor, and overhead costs of producing a product
Appraisal costs: Costs incurred to find mistakes not eliminated through prevention
Conversion costs: The costs (direct labor and overhead) required to convert direct material into a
finished good or service
Cost: The monetary measure of resources given up to attain an objective such as producing a product or
providing a service
Cost allocation: The assignment of an indirect cost to one or more cost objects using some reasonable
allocation base or driver
Cost driver: A factor that has an absolute cause-effect relationship to a cost
Cost management system (CMS): A set of formal methods developed for planning and controlling an
organizations cost-generating activities relative to its strategy, goals, and objectives
Cost object: Anything for which management wants to collect or accumulate costs
Cost of goods manufactured (CGM): The total cost of the goods completed and transferred to Finished
Goods Inventory during the period
Direct costs: Costs which are conveniently and economically traceable to a particular cost object
Direct labor: Labor costs of individuals who work specifically on manufacturing a product or performing a
service
Direct material: Material costs that can be easily and economically traced to a product
Distribution cost: Any cost incurred to warehouse, transport, or deliver a product or service
Expired cost: The portion of an assets value that has been consumed or sacrificed during the period
and which is reported as an expense or loss on the income statement
Failure costs: Internal costs (e.g., scrap and rework) and external costs (e.g., product returns, warranty
costs, complaints to customer service) caused by quality problems
Finished goods: The costs of units of inventory that have been fully completed
Fixed cost: A cost that remains constant in total within the relevant range of activity but varies on a unit
basis
Indirect costs: Costs that cannot be economically traced to a particular cost object and therefore must
be allocated to the object instead
Inventoriable costs: The direct costs of materials and labor plus the indirect costs of overhead which
become part of the cost of inventory
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Manufacturer: A company engaged in a high degree of conversion of raw material that results in a
tangible output
Mixed cost: A cost that has both a variable and a fixed component and that changes with changes in
activity, but not proportionately
Normal cost system: A costing system that charges the Work in Process Inventory with the actual costs
of direct material and direct labor and an assigned amount of overhead based on a predetermined
overhead rate
Overhead: Any factory or production cost that is indirect to the product or service (that is, a productionrelated cost that cannot be directly traced to the product)
Period costs: Costs related to business functions other than production (such as selling and
administrative costs) which are expensed in the current accounting period
Predetermined overhead rate: A charge per unit of activity used to allocate or apply overhead cost from
the Overhead Control account to Work in Process Inventory for the periods production or services
Predictor: An activity measure that, when changed, is accompanied by consistent, observable changes
in a cost item
Prevention costs: Costs incurred to improve quality by precluding product defects and improper
processing from occurring
Prime costs: The primary costs (direct material and direct labor) of producing a product or delivering a
service
Product costs: Costs associated with making or acquiring the products or providing the services that
directly generate the revenues of an entity
Raw material: The materials used in the production process. From the standpoint of conversion, raw
material represents work not yet started
Relevant range: The assumed range of activity that reflects the companys normal operating range and
over which unit variable costs and total fixed costs are assumed to remain constant
Service company: A firm engaged in a high or moderate degree of conversion using a significant amount
of labor
Step cost: A cost that increases (decreases) in distinct amounts because of increased (decreased)
activity. Step variable costs have small steps and step fixed costs have large steps
Total cost to account for: The sum of the beginning WIP Inventory and the total current manufacturing
costs (DM, DL, OH)
Unexpired cost: The portion of an assets value that has not yet been consumed or sacrificed and which
is reported on the balance sheet as an asset
Variable cost: A cost that varies in total proportionately with changes in activity but which is a constant
amount per unit
Work in process: The costs of work started but not yet completed
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Lecture Outline
LO.1
A.
Introduction
1. This chapter provides the necessary terminology to understand and communicate cost and
management accounting information. The chapter also presents cost flows and the process of
cost accumulation in a production environment.
2. To effectively communicate information, accountants must clearly understand the differences
among the various types of costs, their computations, and their usage.
3. To be useful, the term cost must be defined more specifically before the cost of a product or
service can be determined and communicated to others.
a.
b. Unexpired cost: The portion of an assets value that has not yet been consumed or
sacrificed and which is reported on the balance sheet as an asset.
c.
Expired cost: The portion of an assets value that has been consumed or sacrificed during
the period and which is reported as an expense on the income statement.
B.
Cost Terminology
2.
2. Some important types of costs are summarized in text Exhibit 2.1 (p. 25).
3. Association with Cost Object
a.
b.
c.
Direct costs are costs that can be conveniently and economically traced to the cost object.
i.
d.
For example, the cost of steel used by Toyota to manufacture a Highlander SUV is a
direct cost when the cost object is the Highlander product.
For example, the cost of glue used to manufacture a Highlander SUV is an indirect cost
when the cost object is the Highlander SUV.
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e.
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As above, the glue used used to manufacture a Highlander SUV is an indirect cost when
the cost object is the Highlander SUV but is a direct cost when the cost object is the
Princeton plant in which the Highlander is manufactured.
LO.2 What assumptions do accountants make about cost behavior, and why are these
assumptions necessary?
C. Reaction to Changes in Activity
1. General
a.
b.
c.
d.
ii.
iii.
e.
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ii.
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f.
g.
ii.
h.
A predictor is an activity
measure that, when changed, is accompanied by consistent, observable changes in a
cost item. However, simply because two items change together does not prove that the
predictor causes the change.
ii.
iii.
iv.
LO.3 How are costs classified on the financial statements, and why are such classifications
useful?
2.
b.
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publicly accessible website, in whole or in part.
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c.
d.
e.
f.
g.
Period costs are generally more closely associated with a particular time period than with
making or acquiring a product or performing a service.
ii.
Period costs that have future benefit are classified as assets, whereas those having no
future benefit are expenses. For example, prepaid insurance (asset) becomes insurance
expense.
iii. Distribution costs are period costs incurred to warehouse, transport, or deliver a
product or service.
LO.4
How does the conversion process occur in manufacturing and service companies?
D.
See text Exhibit 2.6 (p. 31) for a comparison of the conversion activities of different types of
organizations.
d. Firms that engage in only low or moderate degrees of conversion (such as retailers) can
conveniently expense insignificant costs of labor and overhead related to conversion.
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e. In high-conversion firms, the informational benefits gained from accumulating the material,
labor, and overhead costs incurred to produce outputs significantly exceed clerical
accumulation costs as illustrated in text Exhibit 2.7 (p. 31).
f.
b.
c.
d.
ii.
iii.
e.
f.
In the first stage of processing, the costs incurred reflect the prices paid for raw materials
and/or supplies.
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publicly accessible website, in whole or in part.
ii.
As work progresses through the second stage, accrual-based accounting requires that
labor and overhead costs related to the conversion of raw materials or supplies be
accumulated and attached to the goods.
iii.
The total costs incurred in stages 1 and 2 equal the total production cost of finished
goods in stage 3.
3.
a.
LO.5
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b.
c.
d.
What are the product cost categories, and what items comprise those categories?
E.
Direct Material
a.
b.
c.
See text Exhibit 2.9 (p. 34) for an example of direct vs. indirect
material costs.
2.
Direct labor
a.
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publicly accessible website, in whole or in part.
b.
c.
d.
ii.
iii.
The cost of idle time, which is the time that direct labor
personnel incurr as they sit idle while they are waiting for machines to be maintained or
for materials to arrive to the production floor, should be assigned to overhead.
3.
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Overhead
a.
b.
c.
d.
e.
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publicly accessible website, in whole or in part.
f.
g.
LO.6
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ii.
iii.
iv.
F.
General
a.
b.
c.
2.
Allocating overhead
a.
b.
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c.
d.
Text Exhibit 2.11 (p. 39) presents journal entries to illustrate the
flow of manufacturing costs in an actual cost system while text Exhibit 2.12 (p. 40) presents
selected T-accounts associated with the example.
LO.7 How is cost of goods manufactured calculated and used in preparing an income
statement?
3.
b.
c.
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publicly accessible website, in whole or in part.
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2.
3.
4.
(LO.2) In relation to the dollar amount of Tundra truck sales, which of the
following classifications is appropriate for the truck tires used in production and for the salaries of
production supervisors?
a.
b.
c.
d.
5.
Truck Tires
Variable cost
Fixed cost
Variable cost
Mixed cost
(LO.3) The estimated unit cost for a company planning to produce and
sell at a level of 12,000 units per month is as follows:
Cost Item
Direct material
Direct labor
Variable manufacturing overhead
Fixed manufacturing overhead
Variable selling
Fixed selling
Estimated
Unit Cost
$20
32
6
12
4
4
a.
b.
c.
d.
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$70
$58
$52
$50
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publicly accessible website, in whole or in part.
6.
a.
b.
c.
d.
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(LO.3) Which of the following is not a product cost for Tundra trucks?
Steering wheel
Glue
Salary of product sales manager
Overhead
7.
(LO.4) Which of the following types of firms has the highest degree of
conversion causing a major transformation from input to output?
a.
Lees Landscaping Company
b.
Toyota Manufacturing Company
c.
Wal-Mart Stores
d.
All of the above
8.
9.
10.
(LO.5) Which of the following would be classified as direct labor for the
production of a Tundra truck?
a.
Wages paid to assembly line (production) workers
b.
Bonuses paid to production workers for exceeding production
goals
c.
Production workers Social Security taxes
d.
All of the above
11.
12.
(LO.6) All of the following are reasons why overhead costs are allocated
to cost objects except:
a.
to compare alternative courses of action for management
planning and decision making.
b.
to identify the fixed and variable components of the various
overhead costs.
c.
to determine the full cost of the cost object.
d.
to motivate the manager in charge of the cost object to manage it
efficiently.
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publicly accessible website, in whole or in part.
13.
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(LO.7) A Company had the following inventories at the beginning and end
of January:
January 1
January 31
$11,700
25,100
12,400
The following additional manufacturing data were available for the month of January:
Direct material purchased
Direct labor
Actual factory overhead
$18,900
30,000
17,500
What was the total cost of direct material used for January?
a. $19,900
b. $18,900
c. $17,900
d. $6,500
14.
Finished goods
Work in process
Direct material
January 1
January 31
$125,000
235,000
134,000
$117,000
251,000
124,000
The following additional manufacturing data were available for the month of January:
Direct material used
Direct labor
Actual factory overhead
$189,000
300,000
175,000
Finished goods
Work in process
Direct material
January 1
January 31
$125,000
235,000
134,000
$117,000
251,000
124,000
Assuming the Cost of Goods Manufactured for January was $660,000, what was C Companys
cost of goods sold for January?
a. $676,000
b. $668,000
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c. $666,000
d. $652,000
Multiple Choice Solutions
1.
2.
3.
4.
a (CMA Adapted)
5.
d (CMA Adapted)
Estimated unit conversion costs: Direct labor $32 + Variable OH $6 + Fixed OH $12 = $50
6.
7.
8.
9.
10.
11.
12.
13.
a (CMA Adapted)
Total direct materials used:
Direct materials at January 1
Direct materials purchased
Materials available for use
Less Direct materials at January 31
Direct materials used
14.
d (CMA Adapted)
Cost of goods manufactured:
Work in process at January 1
Total manufacturing cost
Work in process at January 31
Cost of goods manufactured
15.
$13,400
18,900
$32,300
12,400
$19,900
$ 235,000
664,000
(251,000)
$ 648,000
b (CMA Adapted)
Cost of goods sold:
Finished goods at January 1
Cost of goods manufactured
Finished goods at January 31
$ 125,000
660,000
(117,000)
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publicly accessible website, in whole or in part.
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$ 668,000
2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.