TYPES OF COST CLASSIFICATIONS CLASSIFICATION BY BEHAVIOR

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2 18-11 C 2 Cost TYPES OF COST CLASSIFICATIONS CLASSIFICATION BY BEHAVIOR Cost Activity Activity Cost Cost behavior refers to how a cost will react to changes in the level of business activity. Total fixed costs do not change when activity changes. Total variable costs change in proportion to activity changes. Mixed costs are combinations of fixed and variable costs. Activity

3 18-12 C 2 TYPES OF COST CLASSIFICATIONS CLASSIFICATION BY TRACEABILITY Direct costs Costs traceable to a single cost object. Examples: material and labor cost for a product. Indirect costs Costs that cannot be traced to a single cost object. Example: A maintenance expenditure benefiting two or more departments.

4 18-13 C 2 TYPES OF COST CLASSIFICATIONS CLASSIFICATION BY CONTROLLABILITY The degree of control depends on the level of management in the organization.

5 18-14 C 2 TYPES OF COST CLASSIFICATIONS CLASSIFICATION BY RELEVANCE Sunk costs have already been incurred and cannot be avoided or changed. Sunk costs should not be considered in decisions. Example: An automobile purchased two years ago cost $15,000. The $15,000 cost is sunk because whether the car is driven, sold, traded, or abandoned, the cost will not change. Out-of-pocket costs require future outlays of cash and should be considered in decisions. Example: You plan on buying a new car for $25,000 next month. The cost of the new car is an out-of-pocket cost because you can choose to spend or not to spend the $25,000 next month.

6 18-15 C 2 TYPES OF COST CLASSIFICATIONS CLASSIFICATION BY RELEVANCE An opportunity cost is the potential benefit lost by choosing a specific action from two or more alternatives Example: If you were not attending college, you could be earning $20,000 per year. Your opportunity cost of attending college for one year is $20,000.

7 18-16 C 3 TYPES OF COST CLASSIFICATIONS CLASSIFICATION BY FUNCTION Direct Labor Direct Material Manufacturing Overhead Product Period costs are expenses not attached to the product. Selling costs are incurred to obtain orders and to deliver finished goods to customers. Administrative costs are non-manufacturing costs of staff support and administrative functions.

8 18-17 C 3 PERIOD AND PRODUCT COSTS IN FINANCIAL STATEMENTS

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12 18-18 C 3 IDENTIFICATIONS OF COST CLASSIFICATIONS

13 18-19 C 3 COST CONCEPTS FOR SERVICE COMPANIES The cost concepts described are generally applicable to service organizations. For example, the cost of beverages for passengers of Southwest Airlines is a variable cost based on number of passengers.

14 18-20 C 4 REPORTING MANUFACTURING ACTIVITIES Merchandisers... Buy finished goods. Sell finished goods. Manufacturers... Buy raw materials. Produce and sell finished goods. SaleMart

15 18-21 C 4 MANUFACTURER S BALANCE SHEET Raw Materials Goods in Process Finished Goods Materials waiting to be processed. Can be direct or indirect. Partially complete products. Material to which some labor and/or overhead have been added. Completed products for sale.

16 18-22 C 4 MANUFACTURER S BALANCE SHEET MERCHANDISER Current Assets Cash Receivables Merchandise Inventory MANUFACTURER Current Assets Cash Receivables Inventories Raw Materials Goods in Process Finished Goods The primary difference is inventory.

17 18-23 P 1 MANUFACTURER S INCOME STATEMENT

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19 18-24 P 1 COST OF GOODS SOLD FOR A MERCHANDISER AND MANUFACTURER Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.

20 18-25 P 1 Software companies Some service companies such as those providing software services report Cost of Sales. For e.g. Infosys, one of the leading software service companies in the world reports Software development and business process management expenses Something that can be considered equivalent to the Cost of Goods sold in manufacturing companies

21 18-26 P 1 DIRECT MATERIALS Direct material costs are the expenditures for direct materials that are separately and readily traced through the manufacturing process to finished goods. Example: Steel used in the frame of a mountain bike.

22 18-27 P 1 DIRECT LABOR Direct labor costs are the wages and salaries for direct labor that are separately and readily traced through the manufacturing process to finished goods. Example: Wages paid to a mountain bike assembly worker.

23 18-28 P 1 FACTORY OVERHEAD Factory overhead consists of all manufacturing costs that are not direct materials or direct labor and the costs cannot be separately or readily traced to finished goods. Examples: Indirect labor maintenance Indirect material cleaning supplies Factory utility costs Supervisory costs

24 18-29 P 1 PRIME AND CONVERSION COSTS Manufacturing costs are often combined as follows: Direct Material Direct Labor Manufacturing Overhead Prime Cost Conversion Cost

25 18-30 C 5 ACTIVITIES AND COST FLOWS IN MANUFACTURING

26 18-31 P 2 MANUFACTURING STATEMENT Summarizes the types and amounts of costs incurred in a company s manufacturing process. Direct Materials Used + Direct Labor + Factory Overhead = Total Manufacturing Costs + Beginning Work in Process Ending Work in Process = Cost of Goods Manufactured

27 18-32 P 2 MANUFACTURING STATEMENT

28 18-33 P 2 MANUFACTURING STATEMENT

29 18-34 P 2 MANUFACTURING STATEMENT Include all direct labor costs incurred during the current period.

30 18-35 P 2 MANUFACTURING STATEMENT

31 18-36 P 2 MANUFACTURING STATEMENT

32 18-37 P 2 OVERHEAD COST FLOWS ACROSS ACCOUNTING REPORTS

33 18-38 A 1 CYCLE TIME AND CYCLE EFFICIENCY Order Received Production Started Goods Shipped Wait Time Process Time + Inspection Time + Move Time + Queue Time Manufacturing Cycle Time Total Cycle Time Process time is the only value-added time.

34 A 1 CYCLE TIME AND CYCLE EFFICIENCY Order Received Production Started Goods Shipped Wait Time Process Time + Inspection Time + Move Time + Queue Time Manufacturing Cycle Time Total Cycle Time Manufacturing Cycle Efficiency = Value-added time Manufacturing cycle time