1 PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University ©...

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PowerPoint Presentation by Douglas Cloud

Professor Emeritus of AccountingPepperdine University

© Copyright 2005 South-Western, a division of Thomson Learning.All rights reserved.

Task Force Image Gallery clip art included in this electronic presentation is used with the

permission of NVTech Inc.

Task Force Image Gallery clip art included in this electronic presentation is used with the

permission of NVTech Inc.

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Chapter Chapter M2M2 Cost Cost Categories Categories and Flowsand Flows

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Objective 1Objective 1Objective 1Objective 1

Differentiate between product costs and period expenses.

Once you have completed this Once you have completed this chapter, you should be able to:chapter, you should be able to:Once you have completed this Once you have completed this chapter, you should be able to:chapter, you should be able to:

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Pine Belt Furniture Company

manufactures and sells mid-priced

furniture to retailers.

The Production Process The Production Process at Pine Beltat Pine Belt

The Production Process The Production Process at Pine Beltat Pine Belt

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Exhibit 1ContinuedContinuedContinuedContinued

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ContinuedContinuedContinuedContinued Exhibit 1

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Exhibit 1

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Product Costs Versus Product Costs Versus Period ExpensePeriod Expense

Product Costs Versus Product Costs Versus Period ExpensePeriod Expense

Product costs include the cost of materials, labor, and manufacturing overhead consumed in producing the goods.

Product costs include the cost of materials, labor, and manufacturing overhead consumed in producing the goods.

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Product Costs Versus Product Costs Versus Period ExpensesPeriod Expenses

Product Costs Versus Product Costs Versus Period ExpensesPeriod Expenses

Period expenses are the costs of selling and administrative activities,

such as rent, interest, and taxes.

Period expenses are the costs of selling and administrative activities,

such as rent, interest, and taxes.

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Period ExpensesPeriod ExpensesPeriod ExpensesPeriod Expenses

Depreciation of Office Equipment

Office Supplies Used

Administrative Support Salaries

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Direct Material CostsDirect Material CostsDirect Material CostsDirect Material CostsThe costs of significant raw materials from which a product is manufactured are classified as direct material costs.

Lumber Wooden knobs Brass drawer pulls

Examples from Pine Belt Lumber Company:

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Direct Labor CostsDirect Labor CostsDirect Labor CostsDirect Labor Costs

Direct labor costs are the wages of workers who add value to a product through their direct involvement in the production process.

Wages of those who sand the wood Wages of those who apply stain and

polyurethane finish


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Manufacturing Overhead CostsManufacturing Overhead CostsManufacturing Overhead CostsManufacturing Overhead CostsManufacturing overhead costs result from activities that support a manufacturing process but often are not directly related to any specific product.

Cost of saw blades, glue, screws, etc. Electricity for the manufacturing

equipment Fire insurance on factory assets


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Explain how direct materials, direct labor, and manufacturing overhead costs flow though an accounting system.


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Cost Flows Through the Accounting Cost Flows Through the Accounting System of a Manufacturing CompanySystem of a Manufacturing CompanyCost Flows Through the Accounting Cost Flows Through the Accounting System of a Manufacturing CompanySystem of a Manufacturing Company

Raw materials Raw materials inventory inventory

(Direct (Direct materials)materials)



Work-in-Process

Work-in-Process

Direct laborDirect laborDirect laborDirect labor

Manufacturing Manufacturing overheadoverhead


All of these items are assets

ContinuedContinuedContinuedContinued

Finished GoodsFinished GoodsFinished GoodsFinished Goods

Exhibit 2

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Cost Flows Through the Accounting Cost Flows Through the Accounting System of a Manufacturing CompanySystem of a Manufacturing CompanyCost Flows Through the Accounting Cost Flows Through the Accounting System of a Manufacturing CompanySystem of a Manufacturing Company







Work-in-Process

Work-in-Process

Direct laborDirect laborDirect laborDirect labor

Finished GoodsFinished GoodsFinished GoodsFinished Goods

Exhibit 2

Cost of Cost of Goods SoldGoods Sold

Cost of Cost of Goods SoldGoods Sold

Expenses

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Manufacturing Cost FlowManufacturing Cost Flow

Raw Materials

$10,000

The beginning balances of Raw Materials Inventory, Work-in-

Process Inventory, and Finished Goods Inventory are $10,000,

$40,000, and $15,000, respectively.

The beginning balances of Raw Materials Inventory, Work-in-

Process Inventory, and Finished Goods Inventory are $10,000,

$40,000, and $15,000, respectively.

Work-in Process

$40,000Finished Goods

$15,000

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Entry (a): Raw materials costing $50,000 are

purchased.

Entry (a): Raw materials costing $50,000 are

purchased.

Raw Materials Work-in Process Finished Goods

$10,000 $40,000 $15,000+ 50,000 (a)

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Entry (b): Raw materials costing $20,000 are placed

into production.

Entry (b): Raw materials costing $20,000 are placed

into production.


$10,000 $40,000 $15,000+ 50,000 (a)– 20,000 (b) + 20,000 (b)

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Entry (c): Pine Belt incurred direct labor costs

of $8,000 while manufacturing its products.

Entry (c): Pine Belt incurred direct labor costs

of $8,000 while manufacturing its products.


$10,000 $40,000 $15,000+ 50,000 (a)– 20,000 (b) + 20,000 (b)

+ 8,000 (c)

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Entries (d), (e), and (f): Pine Belt incurred

various types of overhead costs

during the production

process.

Entries (d), (e), and (f): Pine Belt incurred

various types of overhead costs

during the production

process.


$10,000 $40,000 $15,000+ 50,000 (a)– 20,000 (b) + 20,000 (b)

+ 8,000 (c)+ 300 (d)

+ 1,000 (e)+ 5,000 (f)

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$10,000 $40,000 $15,000+ 50,000 (a)– 20,000 (b) + 20,000 (b)

+ 8,000 (c)

Entry (g): During the accounting

period, $40,200 of merchandise

is completed and transferred to

finished goods.

Entry (g): During the accounting

period, $40,200 of merchandise

is completed and transferred to

finished goods.

– 40,200 (g)

+ 300 (d)+ 1,000 (e)+ 5,000 (f)

+ 40,200 (g)

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$10,000 $40,000 $15,000+ 50,000 (a)– 20,000 (b) + 20,000 (b)

+ 8,000 (c)

Entry (h): Merchandise

costing $45,000 to manufacture is sold for $70,000.

Entry (h): Merchandise

costing $45,000 to manufacture is sold for $70,000.

+ 300 (d)+ 1,000 (e)+ 5,000 (f)

– 40,200 (g) + 40,200 (g)– 45,000 (h)

Entry (h) results in Cost of Goods Sold increasing

by $45,000

Entry (h) results in Cost of Goods Sold increasing

by $45,000

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$10,000 $40,000 $15,000+ 50,000 (a)– 20,000 (b) + 20,000 (b)

+ 8,000 (c)

Ending balancesEnding balances

+ 300 (d)+ 1,000 (e)+ 5,000 (f)

– 40,200 (g) + 40,200 (g)– 45,000 (h)

$40,000

$34,100

$10,200

Cost of Goods Sold+ 45,000 (h)$45,000

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First, when direct materials are placed into production, their costs become part of Work-in-Process Inventory.

First, when direct materials are placed into production, their costs become part of Work-in-Process Inventory.

Key Points to Remember About Key Points to Remember About Manufacturing Costs FlowManufacturing Costs Flow


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Second, direct labor and overhead costs become part of Work-in-Process Inventory as labor and overhead are used.

Second, direct labor and overhead costs become part of Work-in-Process Inventory as labor and overhead are used.



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Direct labor and overhead often are referred to as conversion costs because they are the costs of activities required

to convert materials into products.

Direct labor and overhead often are referred to as conversion costs because they are the costs of activities required

to convert materials into products.



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Excerpt from the Vulcan Materials Company 2002 Annual Report

Excerpt from the Vulcan Materials Company 2002 Annual Report

Inventories at December 31 were as follows (in thousands of dollars):

2002 2001 2000Finished product $189,378 $176,940 $155,258Raw materials 10,191 13,284 15,578Products in process 486 564 1,020Operating supplies and others 39,531 37,627 27,188 Total inventories $239,586 $228,415 $199,044

Exhibit 4

NOTE 2 INVENTORIES

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Discuss methods for proactively managing inventory levels and manufacturing costs.


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Value ChainValue ChainValue ChainValue Chain

Reliable delivery of quality material and

components from supplier is necessary for a business to meet obligations to its

customers.

Reliable delivery of quality material and

components from supplier is necessary for a business to meet obligations to its

customers.

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Value ChainValue ChainValue ChainValue Chain30

The value chain is the set of value-creating activities that

extends from the production of raw materials, to the sale and servicing of finished goods, to

servicing customers after the sale.

The value chain is the set of value-creating activities that

extends from the production of raw materials, to the sale and servicing of finished goods, to

servicing customers after the sale.

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The Value Chain

Value Chain for Vehicle CarpetsValue Chain for Vehicle CarpetsValue Chain for Vehicle CarpetsValue Chain for Vehicle Carpets

COOL INTERIOR

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Just-in-Time ManufacturingJust-in-Time ManufacturingJust-in-Time ManufacturingJust-in-Time Manufacturing32

Just-in-Time (JIT) is a manufacturing philosophy that

attempts to improve efficiency by reducing inventory levels.



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Just-in-Time ManufacturingJust-in-Time ManufacturingJust-in-Time ManufacturingJust-in-Time Manufacturing





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Just-in-Time ManufacturingJust-in-Time ManufacturingJust-in-Time ManufacturingJust-in-Time ManufacturingThe goal of just-in-time systems is to reduce the length of time it takes to manufacture and deliver a product. Reducing the time required to respond to

customer demands such as cashing checks at banks

Moving finished products faster to reduce inventory

Reducing distribution time once products leave the factory

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Proactively Controlling Costs Proactively Controlling Costs Using Target CostingUsing Target Costing


Traditional Cost-Based PricingTraditional Cost-Based Pricing

1. A product and manufacturing process are designed.

2. The product is manufactured.

3. Manufacturing costs are accumulated.

4. The unit cost plus markup determines the selling price.

5. The company tries to sell the product.

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Unit manufacturing cost x markup percentage = markup

Pine Belt’s management estimates that materials, labor, and overhead cost per unit is $475. Pine Belt generally adds 30% markup

to the unit cost when quoting prices.

Pine Belt’s management estimates that materials, labor, and overhead cost per unit is $475. Pine Belt generally adds 30% markup

to the unit cost when quoting prices.

$475.00 x 0.30 = markup

$142.50 = markup


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Unit manufacturing cost + markup = selling price

$475.00 + $142.50 = $617.50

The wholesale price is set at $618, which means that when the retailer

adds a markup, the chest would sell for approximately $1,000.

The wholesale price is set at $618, which means that when the retailer

adds a markup, the chest would sell for approximately $1,000.


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Retailers are not interested in carrying

the line because consumers are not

willing to pay $1,000 for pine furniture.

Retailers are not interested in carrying

the line because consumers are not

willing to pay $1,000 for pine furniture.

What went wrong?

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Pine Belt failed to analyze the market before developing their new product.

Pine Belt failed to analyze the market before developing their new product.

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The Target Costing ProcessThe Target Costing Process

1. Determine the quality and functionality consumers want in a new product and the price they are willing to pay for that product.

Market research for Pine Belt sets the wholesale price of the chest at $400.

Management has a determined margin of 23%.

Market research for Pine Belt sets the wholesale price of the chest at $400.

Management has a determined margin of 23%.

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1. Determine the quality and functionality consumers want in a new product and the price they are willing to pay for that product.

Margin = selling price x 0.23Margin = $400 x 0.23Margin = $92

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2. Subtract the manufacturer’s required profit margin from the price to determine what the manufacturer can spend to produce the product.

Selling price $400

Less required margin – 92

Target cost $308

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3. Study the feasibility of the new product. Can the company produce a product consumers want at a price the market will accept?




To market the chest successfully, the company must reduce the unit cost of

producing the chest from $475 to $308.

To market the chest successfully, the company must reduce the unit cost of

producing the chest from $475 to $308.

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Cost Plus and Target Cost Plus and Target Costing PhilosophiesCosting PhilosophiesCost Plus and Target Cost Plus and Target Costing PhilosophiesCosting Philosophies

Cost-plus philosophyCost + Markup = Selling price

Exhibit 5

• Cost is the starting point (given)• Markup is added (given)• The firm puts the product on the market and hopes

the selling price is accepted

ContinuedContinuedContinuedContinued

Implications:

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Cost Plus and Target Cost Plus and Target Costing PhilosophiesCosting PhilosophiesCost Plus and Target Cost Plus and Target Costing PhilosophiesCosting Philosophies

• Markets determine prices (given)• Required margin must be sustained for survival

(given)• Target cost is the residual, the variable to be

managed

Target costing philosophySelling price – Required margin = Target costImplications:

Exhibit 5

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THE ENDTHE END

Chapter Chapter M2M2

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