Chapter 02: Cost Terminology and Cost Behaviors IM 9
d. All organizations (retailers, manufacturers, and service firms) need management and cost
E. Components of Product Cost
1. Direct Material
b. Material costs that are not conveniently or economically traceable are classified as indirect
2. Direct labor
a. Direct labor refers to the effort of individuals who manufacture a product or perform a service.
traceable to the product or service.
i. Direct labor should include basic compensation, production efficiency bonuses, the
and included in overhead.
i. Although fringe benefit costs should be treated as direct labor, the time, effort, and
expediting a customer’s request.
iii. The cost of idle time, which is the time that direct labor personnel incurr as they sit idle
i. Now, in highly automated work environments, direct labor often represents only 10 to 15
percent of total manufacturing cost.
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3. Overhead
a. Overhead is any factory or production cost that is indirect to manufacturing a product or
b. Overhead includes indirect material, indirect labor and other production-related costs such as
c. Automated and computerized technologies have made manufacturing more capital intensive
d. Variable overhead includes the costs of indirect material, indirect labor paid on an hourly
e. Fixed overhead includes costs such as straight-line depreciation on factory assets, factory
f. Quality costs are an important component of overhead cost since high-quality products or
i. Prevention costs are incurred to improve quality by precluding product defects and
ii. Appraisal costs are costs incurred for monitoring or inspecting products in order to find
iii. Internal Failure costs are costs such as scrap and rework that result when quality
iv. External Failure costs are incurred when quality problems are not discovered until after
g. Some quality costs are variable in relation to the quantity of defective output, some are step
LO.6 How and why does overhead need to be allocated to products?
F. Accumulation and Allocation of Overhead
1. General
rendered during that period.
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b. Cost allocation refers to the assignment of an indirect cost to one or more cost objects
2. Allocating overhead
a. In an actual cost system, actual direct material and direct labor costs are accumulated in
Work in Process (WIP) Inventory as the costs are incurred. Actual production overhead costs
i. Use of an actual cost system is generally considered to be difficult because all production
accumulated in WIP.
i. A predetermined overhead rate (or overhead application rate) is a charge per unit of
i. A perpetual inventory system, as illustrated in text Exhibit 2.10 (p. 38), continuously
provides current information on the flow of product costs from Raw Materials Inventory
associated with the example.
LO.7 How is cost of goods manufactured calculated and used in preparing an income
statement?
3. Cost of Goods Manufactured and Sold
a. The Cost of Goods Manufactured (CGM) is the total production cost of the goods that were
a retailer.
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b. Information needed for computing CGM is found in the Raw Materials Inventory, Work in
Beginning WIP
+ Cost of Direct Materials Added (See Note 1)
Ending Raw Materials
c. Cost of Goods Sold (CGS)
i. The Cost of goods sold is computed as follows:
Beginning Finished Goods
publicly accessible website, in whole or in part.
Multiple Choice Questions
1. (LO.1) Select the incorrect statement concerning cost objects.
salary would be a direct cost.
b. A direct cost must be conveniently and economically traceable to the cost object.
overhead is an indirect cost.
2. (LO.2) Which of the following statements is correct concerning fixed costs?
range.
3. (LO.2) A utility bill that includes a flat charge for basic service plus a stated rate for each kilowatt
a. mixed cost.
b. step cost.
4. (LO.2) In relation to the dollar amount of Tundra truck sales, which of the following classifications
Truck Tires Production Supervisor Salaries
a. Variable cost Fixed cost
b. Fixed cost Variable cost
5. (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:
Estimated
Cost Item Unit Cost
Direct material $20
Direct labor 32
a. $70
b. $58
c. $52
d. $50
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6. (LO.3) Which of the following is not a product cost for Tundra trucks?
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. Lee’s Landscaping Company
8. (LO.4) Select the incorrect statement concerning the stages of the production or conversion
process.
company’s Supplies inventory account.
b. Firms such as retailers that engage in only low or moderate degrees of conversion ordinarily
have only a single inventory account.
goods.
d. At the point of sale, product costs flow from an inventory account to Cost of Goods Sold
expense.
9. (LO.5) Which of the following would not be classified as direct material for a Tundra truck?
a. Cost of the battery
d. Cost of the fuel tank
10. (LO.5) Which of the following would be classified as direct labor for the production of a Tundra
truck?
c. Production workers’ Social Security taxes
d. All of the above
11. (LO.5) Which of the following costs would not be classified as overhead for the production of
Tundra trucks?
a. Salary of plant manager
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.
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13. (LO.7) A Company had the following inventories at the beginning and end of January:
January 1 January 31
Finished goods $12,500 $11,700
Direct material purchased $18,900
a. $19,900
b. $18,900
c. $17,900
d. $6,500
14. (LO.7) B Company had the following inventories at the beginning and end of January:
January 1 January 31
Finished goods $125,000 $117,000
Direct material used $189,000
a. $672,000
b. $660,000
c. $658,000
d. $648,000
15. (LO.7) C Company had the following inventories at the beginning and end of January:
January 1 January 31
Finished goods $125,000 $117,000
cost of goods sold for January?
a. $676,000
Multiple Choice Solutions
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1. d
2. b
3. a
6. c
7. b
8. a
Total direct materials used:
Direct materials at January 1 $13,400
Direct materials purchased 18,900
14. d (CMA Adapted)
Cost of goods manufactured:
Work in process at January 1 $ 235,000
15. b (CMA Adapted)
Cost of goods sold:
Finished goods at January 1 $ 125,000