However, like many other words, the concept of cost must be defined more specifically before the "cost" can be determined. Expenses for goods sold and expired selling and administrative expenses are examples of expenses. Product costs are also called inventory costs and include the costs of direct materials, direct labor, and overhead.
THE CONVERSION PROCESS Generally, product costs are incurred in the production or conversion area and. This exhibit illustrates that the primary difference between retail companies and manufacturing/service companies is the absence or presence of the area labeled "the production center." This center involves the conversion of raw materials into final products. 3 Gregory White and Brian Coleman, “Chrysler, Daimler Focus on Value of Stock,” The Wall Street Journal (September p.
4Al Haas, “Falling Prices Make It a Great Year for Buying Used Cars,” The (New Orleans) Times-Picayune (July 3, 1998), p.
Separating Mixed Costs
Assuming that a variable cost is constant per unit, and a total fixed cost is constant within the relevant range, can be justified for two reasons. Second, choosing a constant variable cost per unit and a constant total fixed cost a convenient, stable measurement for use in planning, control and decision making. Occasionally, operations may occur at a level outside the relevant range (an urgent special order may be taken requiring excess labor or machine time), or distortions may occur in a normal price within the relevant range (a leak in a water pipe remains unnoticed for a period of time).
This value is multiplied by the level of activity to determine the amount of total variable costs contained in total costs at the (high or low) level of activity. The fixed portion of mixed costs is then determined by subtracting total variable costs from total costs. The change in total mixed costs is equal to the change in activity multiplied by the variable cost per unit; a fixed cost element does not fluctuate with changes in activity.
A potential weakness of the high-low method is that outliers may inadvertently be used in the calculation.
Direct Material
Costs that must be allocated or assigned to a cost object using one or more predictors or cost drivers are called indirect (or common) costs. As the cost object changes, the costs that are direct and indirect to it may also change. For example, if a production division is specified as a cost object, the salary of the production division manager is direct.
If, instead, the cost object is a sales area and the production department operates in more than one area, the production department manager's salary is indirect.
Direct Labor
Therefore, costs for overtime or shift premiums are usually considered overhead rather than direct labor costs and are allocated among all units. If a client requests that a job be scheduled during overtime hours or is in a hurry and requests that overtime be worked, overtime or shift premiums must be considered direct labor and tied to the job that created the cost. Assume that the purchasing agent for People's Seafood Stores ordered a large shipment of gallon-sized freezer bags for delivery in July.
Dewig "understands that we're losing our a—and he's making money faster than he can collect it," the farmer says. Now, in highly automated work environments, direct labor often comprises less than 10 to 15 percent of the total cost of production. Soon, managers may find that almost all direct labor cost is replaced by a new manufacturing cost—the cost of robots and other fully automated machinery.
Consider the accompanying news note on the reduced costs and scope of direct labor in the age of high technology.
Overhead
If you only have to pay 70 people, then the cost of Germany's high wages is no longer relevant," Van der Kooij said. But with their abundance here in Germany, Varta could install its own more advanced equipment, sure to maintain them, repair them and buy the necessary supplies without ever leaving the company's backyard. The only bad sign Motorola's German factory gets," he said, "is for high costs direct labor, but labor accounts for only 2%.
Both levels of quality generate costs that often amount to 20 to 25 percent of sales.10 The two categories of quality costs are the costs of control and the costs of not controlling. In manufacturing, quality costs can be variable in relation to the amount of defective output, a fixed step with increases at specific levels of defective output, or fixed. However, these costs would be extremely high if the number of defective parts produced were high.
In contrast, training costs are determined by management and may not vary regardless of the amount of defective output produced in a given period. At a time when most indoor arenas are spending millions of dollars on a variety of upgrades, from cigar bars to gourmet food, one aspect of the fan experience is quietly shrinking: seat size. A new basketball and hockey arena being built in Atlanta will be state-of-the-art in all but one way: seats that could be as narrow as 18 inches in some places.
If the Orlando Magic hadn't renovated their arena to fit an additional 2,000 seats four years ago," says team manager Pat Williams, "the Magic would have had to raise ticket prices to an unsustainable level." Williams says, "But without the additional seats, we would have been out of business."It's like a sardine can," says a longtime Washington Redskins fan who has season tickets to the team's new Jack Kent Cooke Stadium in suburban Maryland.
Arena officials say it is possible that some fans may have ended up in narrower seats when the team moved there in 1995. This section of the chapter discusses the underlying reasons for cost allocation, using predetermined overhead rates, separating mixed costs into variable and fixed elements, and capacity measures that can be used to calculate predetermined overhead rates.
Why Overhead Costs Are Allocated
Overhead, on the other hand, must be accumulated over a period of time and allocated to the products manufactured or services provided during that period. Cost allocation refers to the allocation of indirect costs to one or more cost objects on a reasonable basis.
Predetermined Overhead Rates
When overhead is underapplied (a debit balance), an insufficient amount of overhead has been applied to production and the closing process results in an increase in cost of goods sold. Alternatively, overapplied overhead (a credit balance) reflects the fact that too much overhead was applied to production, so closing overapplied overhead results in a reduction in cost of goods sold. If the amount of underapplied or overapplied overhead is significant, it should be allocated among the accounts that contain the overhead applied: work-in-process inventory, finished goods inventory, and cost of goods sold.
Second, overhead costs tend to lose their identity after leaving Work in Process Inventory, thus making it more difficult to determine the amount of overhead costs in the Finished Goods Inventory and Cost of Goods Inventory account balances. Solden. In a perpetual inventory system, all product costs flow through work in process inventory to finished goods inventory and, ultimately, to cost of goods sold. The T-accounts in Figure 3–11 provide detailed information about the cost of materials used, goods transferred from work in process, and goods sold.
Therefore, a cost of goods schedule (CGM) is prepared as an initial step in determining cost of goods (CGS).15 CGM is the total production cost of the goods that were completed and transferred to finished goods inventory during the period. This amount corresponds to the cost of net purchases in the cost of goods for a retailer. Formal schedules for cost of goods manufactured and cost of goods sold are presented in Appendix 3-12 using the amounts shown in Appendix 3-10 and 3-11.
The cost of goods manufactured schedule begins with the beginning balance of work in process (WIP) inventory and details all product cost components. Beginning work in process Inventory cost is added to total current period manufacturing cost to obtain a subtotal amount that may be referred to as "total cost to account." The value of ending WIP inventory is calculated (using techniques discussed later in the text) and subtracted from the subtotal to provide the cost of goods manufactured during the period. In the cost of goods sold schedule, the cost of goods manufactured is added to the beginning balance of Finished Goods (FG) Inventory to find the cost of goods available for sale during the period.
Ending finished goods inventory is subtracted from cost of goods available for sale to determine cost of goods sold. Some accountants prefer to streamline the presentation of the summary of costs of goods manufactured and sold when using perpetual inventory accounting.
REVISITING
This amount (if insignificant) must be closed to cost of goods sold or (if significant) distributed between work-in-progress inventory, finished goods inventory and cost of goods sold. Why is the amount of cost of goods manufactured different from the amount of cost of goods sold. Essay) Part of the costs incurred by business organizations are referred to as direct labor costs.
Explain the reasons a company uses to classify cost elements into each of the three categories presented. How much overhead was underapplied or overapplied for each of the three months and for the quarter. Label the graph that illustrates each of the following patterns of cost behavior.
Determine the fixed and variable values for each of the overhead items above and determine the formula for total overhead costs. One of the company's products passes through both departments and uses the following amounts of direct labor and machine time:
