After studying this chapter, you should be able to

1. Define and illustrate a cost object

2. Distinguish between direct costs and indirect costs

3. Explain variable costs and fixed costs

4. Interpret unit costs with caution

5. Distinguish among manufacturing-, merchandising-, and service-sector companies

6. Describe the three categories of inventories commonly foundin manufacturing companies

7. Differentiate between inventoriable costs and period costs

8. Explain why different ways of computing product costs are appropriate for different purposes

CHAPTERAn Introductionto Cost Terms and Purposes

P A R T O N E

Different cost concepts and terms are often used in accounting reports.Managers who understand these concepts and terms are able to (a)best use the information provided, and (b) avoid misuse of that infor-

mation. Communication among managers is greatly facilitated by there beingcommon understanding on the meaning of cost concepts and terms. Thischapter discusses cost concepts and terms found in both internal and externaluses of accounting information.

COSTS AND COST TERMINOLOGY _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _Accountants define cost as a resource sacrificed or forgone to achieve a spe-cific objective. It is usually measured as the monetary amount that must bepaid to acquire goods and services. An actual cost is the cost incurred (a his-torical cost) as distinguished from budgeted or forecasted costs.

To guide their decisions, managers want to know how much a particularthing (such as a product, machine, service, or process) costs. We call this“thing” a cost object, which is anything for which a separate measurement ofcosts is desired. Exhibit 2-1 provides examples of seven different types of costobjects at Procter & Gamble, the consumer products company.

A costing system typically accounts for costs in two basic stages—accumulation and then assignment. Cost accumulation is the collection ofcost data in some organized way by means of an accounting system. Forexample, a plant that purchases paper rolls for printing magazines collects(accumulates) the costs of individual rolls purchased in any one month toobtain the total monthly paper purchase costs. Beyond accumulating costs,managers assign costs to designated cost objects to help decision making.Cost assignment is a general term that encompasses both (1) tracing accu-mulated costs to a cost object, and (2) allocating accumulated costs to a costobject. For example, costs may be assigned to a department to facilitatedecisions about departmental efficiency. Also, costs may be assigned to aproduct or a customer to facilitate product or customer-profitability analy-sis. A key question in cost assignment is whether costs have a direct or anindirect relationship to a particular cost object.

DIRECT COSTS AND INDIRECT COSTS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Cost Tracing and Cost Allocation

■ Direct costs of a cost object are related to the particular cost object andcan be traced to it in an economically feasible (cost-effective) way. Forexample, the cost of the cans or bottles is a direct cost of a Pepsi soft

CHAPTER 22

Learning conceptsUnderstanding terms discussed in thischapter provides the foundation for therest of the course.

Correcting Student Misconceptions

Students have trouble with the distinc-tions between direct/indirect costs and

cost tracing/cost allocation. Familiarexamples can help. Public accountingfirms directly trace direct professionallabor costs to each audit engagement

(through time sheets). In contrast, rent onthe firm’s office and depreciation on its

computers cannot be traced to individualengagements. These are indirect costs

that must be allocated to the differentengagements. Allocation of indirect costs

is a difficult but important topic that iscovered in more detail in Chaps. 5 and 14.

drink. The cost of the cans or bottles can be easily traced to the Pepsisoft drink. The term cost tracing is used to describe the assignment ofdirect costs to the particular cost object.

■ Indirect costs of a cost object are related to the particular cost object but can-not be traced to it in an economically feasible (cost-effective) way. For exam-ple, the cost of quality-control personnel who conduct taste and content testson multiple soft drink products bottled at a Pepsi plant is an indirect cost of aPepsi soft drink. Unlike cans or bottles, it is difficult to trace quality-controlpersonnel costs to a specific Pepsi soft drink. The term cost allocation is used to describe the assignment of indirect costs to the particular cost object.

In Exhibit 2-2 we illustrate direct and indirect costs and both forms ofcost assignment (cost tracing and cost allocation), using the example of SportsIllustrated, the magazine published by Time-Warner. The cost object inExhibit 2-2 is the Sports Illustrated magazine. The paper on which the mag-azine is printed is a direct cost. This paper can be traced to each magazineissue being printed in an economically feasible way. Consider now the cost ofleasing the building that houses the senior editorial staff of such Time-Warner magazines as Time, People, and Sports Illustrated. This leasing costwould be an indirect cost of Sports Illustrated. It is not possible to trace thelease amount to a specific magazine’s editorial staff. It is possible, however, toallocate the lease cost among each magazine product of Time-Warner usingthe relative percentage of total floor space occupied by the editorial group ofeach magazine.

Factors Affecting Direct/Indirect Cost Classifications

Several factors affect the classification of a cost as direct or indirect:

1. The materiality of the cost in question. The greater the cost in question, themore likely that it is economically feasible to trace that cost to a particularcost object. Consider a mail-order catalog company. It would probably beeconomically feasible to trace the courier charges for delivering each packagedirectly to the individual customer. In contrast, the cost of invoice paperincluded in the package sent to the customer is likely to be classified as anindirect cost because it is not economically feasible to trace the cost of thispaper to each customer. The benefits of knowing the exact number of, say, 0.5cents worth of paper included in each package do not exceed the costs ofmoney and time in tracing the costs to each package.

2. Available information-gathering technology. Improvements in this technol-ogy are increasing the percentage of costs classified as direct. Bar codes, forexample, allow many manufacturing plants to treat certain materials previ-

AN INTRODUCTION TO COSTTERMS AND PURPOSES 3

COST OBJECT ILLUSTRATION

Product Crest Tartar Control: Original Flavor toothpaste product

Service Telephone hotline providing information and assis-tance to users of Pampers Diapers products

Project Research and development project on alternativescent-free formulations of Tide detergent products

Customer Safeway, the retailer, who purchases a broad range of Procter & Gamble products

Brand category Vidal Sasson range of hairstyle products

Activity Development and updating of Procter & Gamble’s website on the Internet

Department Environmental, Health, and Safety Department of Procter & Gamble

EXHIBIT 2-1Examples of Cost Objects at Procter & Gamble

1. Define and illustrate a cost objective.

Cost objectsIinclude: activities or processes; outputsof processes, such as products, services,and projects; parts of the organization(e.g., departments or programs); and customers.

Teaching TipHelp students internalize these conceptsby making them concrete. Divide theclass into groups of about four studentseach. Assign one set of cost terms toeach group (e.g., direct/indirect costs,cost objects/cost drivers, VC/FC, etc.) Askeach group to (1)define the terms (withbooks closed), (2) give examples basedon their work experience, and (3) think ofa specific decision where the conceptswould be relevant.

2. Distinguish between direct costs and indirect costs.

Cost assignmentCost assignment is a general term for

attaching either direct or indirect costs tocost objects. The distinction betweendirect and indirect costs is important

because direct costs are directly tracedto the cost object, while indirect costs

are ofter posted and then allocated to thecost object with less precision. Mgt.

therefore, has more confidence in theaccuracy of direct costs. The text uses

the term cost tracing to refer specificallyto assigning direct costs to cost object.

Cost allocation is reserved for assigningindirect costs to cost objects.

COST ASSIGNMENT COST OBJECT

Example: Sports Illustratedmagazine

Cost Allocation

Cost Tracing

Indirect Costs

Example: Lease cost forTime-Warner buildinghousing the senior editorsof its magazines

Direct Costs

Example: Paper onwhich Sports Illustratedmagazine is printed

Teaching TipHelp students internalize these concepts

by making them concrete. Divide theclass into groups of about four students

each. Assign one set of cost terms toeach group (e.g., direct/indirect costs,cost objects/cost drivers, VC/FC, etc.).Ask each group to (1) define the terms(with books closed), (2) give examples

based on their work experience, and (3)think of a specific decision where the

concepts would be relevant.

EXHIBIT 2-2Cost Assignment to a Cost Object

Purposes for Companies Distinguishing between Variable Costs and Fixed Costs

ously classified as indirect costs as direct costs of products. Many componentparts now come with a bar code on them that can be scanned at every point inthe production process.

3. Design of operations. For example, classifying a cost as direct is facilitated ifan organization’s facility (or part thereof) is used exclusively for a specific costobject, such as a specific product or a particular customer.

4. Contractual arrangements. For example, a contract stating that a givencomponent (an Intel Pentium chip) can be used only in a specific product(an IBM PC) makes it easier to classify the component

EXHIBIT 3-4Spreadsheet Analysis of CVP Relationships for Do-All Software

Revenues Required at $200 Selling Price

to Earn Operating Income of

Variable

Fixed Costs

Costs Per Unit $0 $1,000 $1,500 $2,000

$2,000 $100 $ 4,000 $ 6,000 $ 7,000 $ 8,000120 5,000 7,500 8,750 10,000140 6,667 10,000 11,667 13,333

2,500 100 5,000 7,000 8,000 9,000120 6,250 8,750 10,000 11,250140 8,333 11,667 13,333 15,000

3,000 100 6,000 8,000 9,000 10,000120 7,500 10,000 11,250 12,500140 10,000 13,333 15,000 16,667

ILLUSTRATING THE FLOW OF INVENTORIABLE COSTS AND PERIOD COSTS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Manufacturing-Sector Example

The income statement of a manufacturer, Cellular Products, is shown inExhibit 2-6. Revenues of Cellular are (in thousands) $210,000. Revenues areinflows of assets (almost always cash or accounts receivable) received forproducts or services provided to customers. Cost of goods sold in a manufac-turing company is often computed as follows:

Beginning Cost of Ending Cost offinished goods � goods � finished goods � goods

inventory manufactured inventory sold

For Cellular Products in 2001, the corresponding amounts (in thousands)in Exhibit 2-6 (Panel A) are:

Cost of goods manufactured refers to the cost of goods brought tocompletion, whether they were started before or during the current account-ing period. In 2001, these costs amount to $104,000 for Cellular Products(see the Schedule of Cost of Goods Manufactured in Panel B of Exhibit 2-6).A line item in Panel B is “Manufacturing costs incurred during the period” of$105,000. This item refers to the direct manufacturing costs and the indirectmanufacturing costs that were incurred during 2001.

Types of Inventory

Manufacturing-sector companies purchase materials and components andconvert them into different finished goods. They typically have one or moreof the following three types of inventor:

1. Direct materials inventory. Direct materials in stock and awaiting usein the manufacturing process.3

2. Work-in-process inventory. Goods partially worked on but not yetfully completed. Also called work in progress.

3. Finished goods inventory. Goods fully completed but not yet sold.

$22,000 � $104,000 � $18,000 � $108,000

CHAPTER 2AN INTRODUCTION TO COSTTERMS AND PURPOSES 54

Points to Stress Merchandisers’ and mfg. firms’ income

statements differ only in the CGS section.Manufacturing firms’ CGS is based on the

cost of goods they manufactured,whereas merchandisers’ CGS is based on

their purchases of FG from others. Notealso the difference in the inventory

accounts (3 for mfg. firms and 1 for mer-chandising firms).

SURVEYS OF COMPANY PRACTICE

Purposes for Companies Distinguishing between Variable Costs and Fixed Costs

Many chapters in this book illustrate the insights gained from distinguishing betweenvariable costs and fixed costs. One survey of U.S. companies reported the followingranking of purposes for distinguishing between variable and fixed costs (1 5 mostimportant purpose).

Chapter(s) in This BookRank Purpose Discussing the Purpose in Detail

1 (equal) Pricing 4, 5, 11, 12, and 13

1 (equal) Budgeting 6

3 Profitability analysis—existing products 4, 5, 11, 12, and 13

4 Profitability analysis—new products 11, 12, and 13

5 Cost-volume-profit (CVP) analysis 3

6 Variance analysis 7, 8, and 16

Surveys of Australian, Japanese, and United Kingdom companies provide additionalevidence on the ranking by managers of the many purposes for distinguishing betweenvariable costs and fixed costs (1 5 most important purpose):b

Ranking by

Australian Japanese United KingdomPurpose Companies Companies Companies

Pricing decisions 1 5 1Budgeting 2 2 3Making profit plans 3 1 2Cost reduction 6 3 5 (equal)CVP analysis 4 (equal) 4 4Cost-benefit analysis 4 (equal) 6 5 (equal)

These surveys highlight the wide range of decisions for which managers feel an under-standing of cost behavior is important.aAdapted from Mowen, Accounting for Costs as Fixed and Variable.

bBlayney and Yokoyama, “Comparative Analysis of Japanese and Australian Cost Accounting and Management Practices.”Full citations are in Appendix A at the end of the book.

Correcting StudentMisconceptions\ExampleStudents are frequently confused by twoaspects of direct/indirect costs. First, thedistinction is based on a judgmentregarding the economic feasibility ofspecifically tracing the cost in that par-ticular situation.

Correcting Student Misconceptions

Students are often confused about thecategory of inventory used in a mfg. firm’s

CGS section. Normally, only FG are sold,so FG is the inventory used to adjust CGM

to obtain CGS.

Correcting StudentMisconceptions

Do total costs = prime costs + conver-sion costs? Only under the two-part

classification where prime costs =direct material costs and conversioncosts = indirect manufacturing costs

(including direct mfg. labor). In thethree-part classification, direct mfg.

labor is both a prime cost and a con-version cost. Thus, in the three-partclassification, prime costs and con-

version costs are not mutually exclu-sive categories.

1Cost-behavior questions appear in professional examinations with regularity. For example,see the supplement to this textbook: J. K. Harris, Student Guide and Review Manual (UpperSaddle River, N.J.: Prentice Hall, 2000). The first three chapters of this supplement are avail-able, free of charge, at Prentice Hall’s website: (www.prenhall.com/harris).

3. Cost of goods manufacturedabout brought to completion,whether they were started.

CHAPTER 26 AN INTRODUCTION TO COSTTERMS AND PURPOSES 7

Harley-Davidson Eliminates the Direct Manufacturing Labor Cost Categorya Harley-Davidson’s Motorcycle Division for many years used a three-part costclassification in its manufacturing facilities—direct materials, direct manufac-turing labor, and manufacturing overhead. In the mid-1980s, a task force ofHarley-Davidson managers analyzed how its manufacturing product-coststructure compared with the administrative costs required to collect, inspect,and report data in its accounting system, with the following results:

ManufacturingProduct-Cost Administrative

Structure Cost Effort

Direct materials 54% 25%Manufacturing overhead 36 13Direct manufacturing labor 10 62

The administrative costs associated with tracking directmanufacturing labor as a separate cost category included:

■ Operator’s time to fill out labor tickets■ Supervisor’s time to review labor tickets■ Timekeeper’s time to enter the labor data and review

the output reports for errors■ Cost accountant’s time to review the direct-labor

and variance data

Harley-Davidson concluded that tracing direct manufacturing labor to productsdid not meet the cost-benefit test. Direct manufacturing labor costs were only10% of total manufacturing costs but required 62% of the administrative effortused to track all manufacturing costs. The company now includes all manufac-turing labor costs as part of manufacturing overhead costs. It uses a two-partclassification of direct materials and manufacturing overhead.

aAdapted from W. Turk, “Management Accounting Revitalized: The Harley-Davidson Experience,”Journal of Cost Management, Vol. 3. No. 4.

MEASURING COSTS REQUIRES JUDGMENT

Judgment is frequently required when measuring costs. Differences can existin the way accounting terms are defined. Care should be taken to define andunderstand the way costs are measured in any organization or situation inwhich costs are an issue. We first illustrate this point with respect to laborcost measurement.

Measuring Labor Costs

Manufacturing labor cost classifications vary among companies, but the fol-lowing distinctions are generally found:

Direct manufacturing labor (defined earlier)Manufacturing overhead (examples of prominent labor components ofthis manufacturing overhead follow):Indirect labor (compensation)

Forklift truck operators (internal handling of materials)JanitorsPlant guardsRework labor (time spent by direct laborers redoing defective work)

Direct ManufacturingPoints to Stress The text uses the term

direct manufacturing labor because laborincurred in other elements of the value

chain can also be traced directly to costobjects. For example, in some cases,sales labor can be traced directly to

specific customers.

whensalesoccurMerchandise

Purchases

BALANCE SHEET

Revenues

deduct

Equals Gross Margindeduct

Equals Operating Income

INCOME STATEMENT

InventoriableCosts

PeriodCosts

Cost ofGoods Sold

(an expense)

Design CostsOperating Costs

(such as Purchasing Dept. Costs)Marketing Costs

Distribution CostsCustomer-Service Costs

MerchandiseInventory

EXHIBIT 2-8Relationships of Inventoriable Costs and Period Costs

PANEL B: MERCHANDISING COMPANY (RETAILER OR WHOLESALER)

aExamples: Indirect manufacturing labor, plant supplies, insurance and depreciation on plant. (Note particu-larly that where insurance and depreciation relate to the manufacturing function, they are inventoriable, but where they relate to nonmanufacturing business functions (for example, marketing and distribution), they are not inventoriable.

PANEL A: MANUFACTURING COMPANY

Work inProcess

Inventory

Other DirectManufacturing

Costs

whensalesoccur

IndirectManufacturing

Costsa

DirectMaterialsInventory

BALANCE SHEET

Revenues

deduct

Equals Gross Margindeduct

Equals Operating Income

INCOME STATEMENT

DirectMaterials

Purchases

InventoriableCosts

PeriodCosts

FinishedGoods

Inventory

Cost ofGoods Sold

(an expense)

R&D CostsDesign Costs

Marketing CostsDistribution Costs

Customer-Service Costs

CONCEPTS IN ACTION

9AN INTRODUCTION TO COSTTERMS AND PURPOSESCHAPTER 28 PROBLEM FOR SELF STUDY

(Try to solve this problem before examining the solution that follows.)

PROBLEMCampbell Company is a metal and wood cutting manufacturer, selling products to the homeconstruction market. Consider the following data for the year 2001:

1. Prepare an income statement with a separate supporting schedule of cost of goods manufactured.For all manufacturing items, indicate by V or F whether each is basically a variable cost or a fixedcost (where the cost object is a product unit). If in doubt, decide on the basis of whether the totalcost will change substantially over a wide range of units produced.

2. Suppose that both the direct materials and plant-leasing costs are tied to the production of 900,000units. What is the unit cost for the direct materials assigned to each unit produced? What is theunit cost of the plant-leasing costs? Assume that the plant-leasing costs are a fixed cost.

3. Repeat the computation in requirement 2 for direct materials and plant-leasing costs, assumingthat the costs are being predicted for the manufacturing of 1,000,000 units next year. Assume thatthe implied cost-behavior patterns persist.

4. As a management consultant, explain concisely to the president why the unit costs for direct mate-rials did not change in requirements 2 and 3 but the unit costs for plant-leasing costs did change.

SOLUTION

1.

2.

� $54,000 � 900,000 � $0.06 Plant-leasing unit cost � Plant-leasing costs � Units produced

� $450,000 � 900,000 � $0.50 Direct material unit cost � Direct materials used � Units produced

Sandpaper $ 2,000Materials-handling costs 70,000Lubricants and coolants 5,000Miscellaneous indirect manufacturing labor 40,000

Direct manufacturing labor 300,000Direct materials, Jan. 1, 2001 40,000Direct materials, Dec. 31, 2001 50,000Finished goods, Jan. 1, 2001 100,000Finished goods, Dec. 31, 2001 150,000Work in process, Jan. 1, 2001 10,000Work in process, Dec. 31, 2001 14,000

Campbell CompanyIncome Statement

For the Year Ended December 31, 2001

Revenues $1,360,000Cost of goods sold:

Beginning finished goods, January 1, 2001 $ 100,000Cost of goods manufactured (see schedule below)Cost of goods available for sale 1,060,000Ending finished goods, December 31, 2001

Gross margin (or gross profit) 450,000Marketing, distribution and customer-service costs

Marketing promotions 60,000Marketing salaries 100,000Distribution costs 70,000Customer-service costs

Operating income $ 120,000 330,000 100,000

910,000 150,000

960,000

3. The direct material costs are variable, so they would increase in total from $450,000 to $500,000(1,000,000 � $0.50). However, their unit costs would be unaffected: $500,000 � 1,000,000 units �$0.50.

In contrast, the plant-leasing costs of $54,000 are fixed, so they would not increase in total.However, the plant-leasing costs per unit would decline from $0.060 to $0.054: $54,000 �1,000,000 � $0.054.

4. The explanation would begin with the answer to requirement 3. As a consultant, you should stressthat the unitizing (averaging) of costs that have different behavior patterns can be misleading. Acommon error is to assume that a total unit cost, which is often a sum of variable unit costs andfixed unit costs, is an indicator that total costs change in a wholly variable way as production levelschange. The next chapter demonstrates the necessity for distinguishing between cost-behavior pat-terns. You must be wary especially about average fixed costs per unit. Too often, unit fixed costs areerroneously regarded as being indistinguishable from unit variable costs.

DECISION GUIDELINES SUMMARY SUMMARY

Accounting for Current and Contingent Liabilities, Including Payroll

Plant-leasing costs 54,000Depreciation—plant equipment 36,000Property taxes on plant equipment 4,000Fire insurance on plant equipment 3,000Direct materials purchased 460,000Revenues 1,360,000Marketing promotions 60,000Marketing salaries 100,000Distribution costs 70,000

Customer-service costs100,000

REQUIRED

DECISION

What are the two main issues in accounting for current liabilities?

GUIDELINES

• Recording the liability on the balance sheet• Current liabilities of known amount:

Accounts payable Accrued expensesShor-term notes payable (accrued liabilities)Sales tax payable Payroll liabilitiesCurrent portion of long-term debt Salary, wages, commission, and bonus payableUnearned revenues

DECISION

What are the two basic categories of current liabilities?

GUIDELINES

• Current liabilities that must be estimated:Estimated Warranty payableEstimated warranty payableEstimated vacation pay liabilityIncome tax payable (for a corporation)

DECISION

How to account for contingent (potential) liabilities?

GUIDELINES

Report contingent liabilities either• Short (with no dollar amount) on the balance sheet, along with an explanatory note,

or• With only the explanatory note

DECISION

What is the ethical and legal challenge in accounting for current and contingent liabilities?

GUIDELINES

To ensure that the balance sheet (and the related notes) reports the full amount of allthe business’s current and contingent liabilities.

11

1. What is the unit cost to ECG of Wang’s software code included in itse.procurement package if it sells (a) 2,000 packages, (b) 6,000 packages, (c)10,000 packages, and (d) 20,000 packages? Comment on the results.

2. To predict ECG’s total cost of using Wang’s software code in e.procurement,which unit cost (if any) of (a) to (d) in requirement 1 would you recommendECG use? Explain.

2-18 Computing and interpreting unit manufacturing costs. Finish ForestProducts (FFP) produces three different paper products at its Vaasa lumberplant—Supreme, Deluxe, and Regular. Each product has its own dedicated pro-duction line at the plant.

INTERNET EXERCISE

Starbucks Corporation is the number 1 specialty coffee retailer, operatingmore than 2,800 shops. The company also sells coffee beans to restaurants,businesses, airlines, and hotels, and offers mail order and on-line shopping.

1. Go to http://www.forbes.com and under “Stocks” type SBUX, the stock symbol for Starbucks Corporation. Click on Go. In the left hand column, click on Company Info, and scan the information provided. What one-year sales growth was reported?

2. In the left-hand column, click on Financials. For the most recent year identify or compute the amounts reported for total revenue, cost of goods sold, and operating expenses. Calculate operating income.

EXCELL APPLICATION PROBLEMGOAL: Create an Excel spreadsheet that compares gross profit, endinginventory, and cost of goods sold under the LIFO, FIFO, and weighted-aver-age methods of inventory valuation.

SCENARIO: John Kalinich, Chief Operations Officer at Teva Sport Sandalsin Flagstaff, Arizona, has a decision to make. He’s in charge of Teva’s on-linestore, and is responsible for the inventory sold through the Web. John mustdecide which inventory method to use for the business.

Your task is to create a spreadsheet and embedded graph that comparesgross profit, ending inventory, and cost of goods sold under three methods:weighted average, FIFO, and LIFO. John has provided the following datafrom the most recent month of operations for your use in creating thespreadsheet:

July 1 Beginning inventory 2,000 units @ $30.00 cost per unit6 Purchase 600 units@ $31.25 cost per unit

17 Purchase 400 units @ $33.50 cost per unit28 Purchase 200 units@ $34.75 cost per unit

Sales for July: 1,800 pairs of sandals sold @ $69.00 eachAfter you have prepared your spreadsheet, answer these questions:

1. Which method produces the lowest cost of goods sold?2. Which method produces the lowest ending inventory?3. If john Kalinich wants to maximize gross profit for Teva, which

method should he choose? Does this method do a good job of matching inventory expense (cost of goods sold) t sales revenue?

STEP-BY-STEP:

1. Open a new Excel Spreadsheet.2. Create a heading for your spreadsheet that contains the following:

a. Chapter 9 Decision Guidelinesb. Inventory Management

AN INTRODUCTION TO COSTTERMS AND PURPOSES

QUESTIONS2-1 Define cost object and give three examples.2-2 Define direct costs and indirect costs. How are these terms related?2-3 Why do managers consider direct costs to be more accurate than indirect

costs?2-4 Name three factors that will affect the classification of a cost as direct or

indirect.2-5 Describe how manufacturing-, merchandising-, and service-sector compa-

nies differ from each other.2-6 What is a cost driver? Give one example.2-7 Define variable cost and fixed cost. Give an example of each.2-8 What is the relevant range? What role does the relevant range concept play

in explaining how costs behave?2-9 Explain why unit costs must often be interpreted with caution.

2-10 What are three different types of inventory that manufacturing companieshold?

2-11 Distinguish between inventoriable costs and period costs.2-12 Do service-sector companies have inventoriable costs? Explain.2-13 Define the following: direct materials costs, direct manufacturing labor costs,

indirect manufacturing costs, prime costs, and conversion costs.2-14 Describe the overtime premium and idle time categories of indirect labor.2-15 Define product cost. Describe three different purposes for computing prod-

uct costs.

EXERCISES2-16 Total costs and unit costs. A student association has hired a musicalgroup for a graduation party. The cost will be a fixed amount of $4,000.

1. Suppose 500 people attend the party. What will be the total cost of themusical group? The unit cost per person?

2. Suppose 2,000 people attend. What will be the total cost of the musicalgroup? The unit cost per person?

3. For prediction of total costs, should the manager of the party use the unitcost in requirement 1? The unit cost in requirement 2? What is the majorlesson of this exercise?

2-17 Total costs and unit costs. Agree to a contract where ECG pays Wang a flatfee of $100,000 for the right to use her code in up to 10,000 packages. If e.procure-ment sells more than 10,000 packages, Wang receives an additional $8 for each pack-age sold beyond the 10,000.

CHAPTER 210 TERMS TO LEARN

ASSIGNMENT MATERIAL

actual cost (p. 28)average cost (33)conversion costs (39)cost (28)cost accumulation (28)cost allocation (29)cost assignment (28)cost driver (31)cost object (28)

cost of goods manufactured (37)direct costs of a cost object (28)direct manufacturing labor costs (36)direct materials costs (36)direct materials inventory (35)factory overhead costs (36)finished goods inventory (35)fixed cost (30)idle time (42)

indirect costs of a cost object (29)indirect manufacturing costs (36)inventoriable costs (36)manufacturing overhead costs (36)manufacturing-sector company (35)merchandising-sector company (35)operating income (38)overtime premium (42)

REQUIRED

REQUIRED

This chapter contains more basic terms than any other in this book. Do notproceed before you check your understanding of the following terms. Boththe chapter and the Glossary at the end of the book contain definitions.

C0M25Y5K0 C5M0Y35K0 C15M5Y0K0 C0M20Y30K0 C10M25Y30K0

C5M0Y40K0 C25M0Y50K0 C30M10Y0K0 C45M0Y5K0 C100M0Y0K0

C100M50Y0K0 C100M100Y5K0

C0M10Y100K0 C70M60Y0K0

C100M0Y30K0

C0M10Y40K0 C20M40Y100K0