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CHAPTER 2
BASIC COST MANAGEMENT CONCEPTS
Learning Objectives
2. Distinguish among product costs, period costs, and expenses.
4. List five types of manufacturing operations and describe mass customization.
6. Prepare a schedule of cost of goods manufactured, a schedule of cost of goods
sold, and an income statement for a manufacturer.
8. Describe the behavior of variable and fixed costs, in total and on a per-unit basis.
10. Define and give examples of an opportunity cost, an out-of-pocket cost, a sunk
cost, a differential cost, a marginal cost, and an average cost.
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Chapter Overview
I. What Do We Mean by a Cost?
A. Product costs, period costs, and expenses
II. Costs on Financial Statements
A. Income statement
2. Costs of manufactured inventory
B. Balance sheet
2. Work-in-process inventory
3. Finished-goods inventory
III. Manufacturing Operations and Manufacturing Costs
A. Job shop, batch, assembly line, continuous flow
B. Assembly manufacturing
C. Manufacturing costs
2. Direct labor
4. Indirect material
6. Other manufacturing costs
7. Conversion cost, prime cost
IV. Manufacturing Cost Flows
A. Cost of goods manufactured
B. Production costs in service industry firms and nonprofit organizations
V. Basic Cost Management Concepts: Different Costs for Different Purposes
A. The cost driver team
B. The cost management and control team
1. Direct and indirect costs
2. Controllable and uncontrollable costs
C. The outsourcing action team
1. Opportunity costs
3. Sunk costs
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5. Marginal and average costs
D. Costs and benefits of information
VI. Costs in the Service Industry
A. Product and period costs
B. Variable and fixed costs
C. Controllable and uncontrollable costs
D. Opportunity, out-of-pocket, and sunk costs
E. Differential, marginal, and average costs
Key Lecture Concepts
I. What Do We Mean by a Cost?
• A cost is the sacrifice made to achieve a particular purpose.
• There are different costs for different purposes, with costs that are
appropriate for one use being totally inappropriate for others (e.g., a cost
• An expense is defined as the cost incurred when an asset is used up or
sold for the purpose of generating revenue. The terms “product cost” and
“period cost” are used to describe the timing with which expenses are
recognized.
➢ Product costs are the costs of goods manufactured or the cost of
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II. Costs on Financial Statements
• Product costs are shown as cost of goods sold on the income statement
• Product costs, housed on the balance sheet until sale, are found in three
inventory accounts:
III. Manufacturing Operations and Manufacturing Costs
• There are various types of production processes; for example:
➢ Job shop—low production volume, little standardization; one-of-a-
• Direct materials—materials easily traced to a finished product (e.g., the
• Direct labor—the wages of anyone who works directly on the product
• Manufacturing overhead—all other manufacturing costs such as:
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➢ Indirect labor—personnel who do not work directly on the product
➢ Other manufacturing costs not easily traceable to a finished good
➢ Idle time – time that is not spent productively by an employee due
• Conversion cost (the cost to convert direct materials into finished
IV. Manufacturing Cost Flows
• Manufacturing costs (direct materials, direct labor, and manufacturing
• Cost of goods manufactured: Direct materials used + direct labor +
manufacturing overhead + beginning work-in-process inventory – ending
work-in-process inventory
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Beginning Cost of Goods Ending
Inventory, + Manufactured – Inventory, = Cost of
Finished Goods to Completion Finished Goods Goods Sold
V. Basic Cost Management Concepts: Different Costs for Different Purposes
• A cost driver is any event or activity that causes costs to be incurred. Cost
driver examples include labor hours in manual assembly work and
machine hours in automated production settings.
• Variable and fixed costs
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➢ Fixed costs remain constant in total as the level of activity changes.
• Direct and indirect costs
➢ A direct cost is one that can be easily traced to a cost object.
▪ If a college department has been defined as the cost object,
➢ An indirect cost is a cost that cannot be easily traced to a cost
object.
▪ For example, the costs of a university’s controller, president,
➢ A cost management system strives to trace costs to the objects that
caused them so that managers can isolate responsibility for
spending and objectively evaluate operations.
Teaching Tip: When discussing indirect costs, you may want to cite a
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• Controllable and uncontrollable costs
• Sunk cost—a cost incurred in the past that cannot be changed by future
action (e.g., the cost of existing inventory or equipment)
• Differential cost—the net difference in cost between two alternative
courses of action
• Marginal cost—the extra cost incurred when one additional unit is
produced
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VI. Costs in the Service Industry
Teaching Overview
The main purpose of Chapter 2 is to expand the way in which costs are defined and
viewed. After completing a course in financial accounting, students are very much
Before discussing manufacturing costs, I ask for a show of hands from students who
have actually visited a manufacturing plant. The typical, small number of hands serves
as a reminder that many students have little idea of what a factory “looks like” and
In summary, Chapter 2 discusses the many ways that costs can be categorized. Chapter
3 then follows with a discussion of a system to track product costs and answers the age-
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Links to the Text
Homework Grid
Item No.
Completion
Time (min.)
Special
Features*
Exercises:
2-24
20
2-25
10
2-26
10
2-27
10
2-28
25
2-29
30
C
2-30
15
2-31
5
I
2-32
15
2-33
5
2-34
10
2-35
10
2-36
15
Problems:
2-37
25
2-38
15
2-39
20
C
2-40
10
2-41
10
2-42
20
2-43
35
S
2-44
30
2-45
40
S
2-46
25
2-47
25
2-48
25
2-49
15
2-50
20
2-51
40
W
2-52
25
2-53
15
2-54
20
2-55
10
2-11
2-56
25
2-57
15
2-58
25
Cases:
2-59
30
W, G
2-60
50
W, E