CHAPTER 2

REVIEW PROBLEM 1: COST TERMS

Many new cost terms have been introduced in this chapter. It will take you some
time to learn what each term means and how to properly classify costs in an
organization. Consider the following example:

Chippen Corporation manufactures furniture, including tables. Selected costs

are given below:

1. The tables are made of wood that costs $100 per table.

=> Product cost (DM), Variable cost

2. The tables are assembled by workers, at a wage cost of $40 per table.

=> Product cost (DL), Variable cost

3. Workers making the tables are supervised by a factory supervisor who is paid
$38,000 per year.

=> Product cost (MO), Fixed cost

4. Electrical costs are $2 per machine-hour. Four machine-hours are required to

produce a table.

=> Product cost (MO, Utilities cost), Variable cost

5. The depreciation on the machines used to make the tables totals $10,000 per
year. The machines have no resale value and do not wear out through use.

=> Product cost (MO, Depreciation), Sunk cost, Fixed cost

6. The salary of the president of the company is $100,000 per year.

=> Period cost (Administrative cost), Fixed cost

7. The company spends $250,000 per year to advertise its products.

=> Period cost (Selling cost), Fixed cost

8. Salespersons are paid a commission of $30 for each table sold.

=> Period cost (Selling cost), Variable cost

9. Instead of producing the tables, the company could rent its factory space for
$50,000 per year.
=> Opportunities cost

Required:

Classify these costs according to the various cost terms used in the chapter.
Carefully study the classification of each cost. If you do not understand why a
particular cost is classified the way it is, reread the section of the chapter
discussing the particular cost term. The terms variable cost and fixed cost refer
to how costs behave with respect to the number of tables produced in a year.

REVIEW PROBLEM 2: SCHEDULE OF COST OF GOODS

MANUFACTURED AND INCOME STATEMENT

The following information has been taken from the accounting records of Klear-
Seal Corporation for last year:

Management wants these data organized in a better format so that financial

statements can be prepared for the year.

Required:

1. Prepare a schedule of cost of goods manufactured as in Exhibit 2-5. Assume

raw materials consists entirely of direct materials.

2. Compute the cost of goods sold as in Exhibit 2-3.

3. Prepare an income statement.

ANSWER

1.
- DM: Beginning raw materials + Purchases of raw materials – Ending raw materials

= 90 + 750 – 60 = 780

- DL: 150

- MO: Indirect materials + Indirect manufacturing labor + factory lease + Machine

depreciation + others MO

= 30 + 75 + 306 + 204 + 25 = 640

- Cost of goods manufactured: Total manufactured cost + Beginning WIP – Ending

WIP

= (780 + 150 + 640) + 180 – 100 = 1650

2. COGS: Cost of goods manufactured + Beginning FGs – Ending FGs

= 1650 + 260 - 210 = 1700

E 2.1 CLASSIFYING MANUFACTURING COSTS [L01]

The PC Works assembles custom computers from components supplied by

various manufacturers. The company is very small and its assembly shop and
retail sales store are housed in a single facility in a Redmond, Washington,
industrial park. Listed below are some of the costs that are incurred at the
company.

Required:

For each cost, indicate whether it would most likely be classified as direct labor,
direct materials, manufacturing overhead, selling, or an administrative cost.

1. The cost of a hard drive installed in a computer.

=> Product cost (DM), Variable cost

2. The cost of advertising in the Puget Sound Computer User newspaper.

=> Period cost (Selling cost), Fixed cost

3. The wages of employees who assemble computers from components.

=> Product cost (DL), Fixed cost

4. Sales commissions paid to the company's salespeople.

=> Period cost (Selling cost), Variable cost

5. The wages of the assembly shop's supervisor.

=> Product cost (MO), Fixed cost

6. The wages of the company's accountant.

=> Period cost (Administrative cost), Fixed cost

7. Depreciation on equipment used to test assembled computers before release to

customers.

=> Product cost (MO, Depreciation), Sunk cost, Fixed cost

8. Rent on the facility in the industrial park.

=> Product cost (MO), Fixed cost

E 2.2 COST TERMINOLOGY FOR MANUFACTURERS [L01, L02]

Arden Company reported the following costs and expenses for the most recent
month:

Required:

1. What is the total amount of product costs?

=> Product cost = DM + DL + MO = 80 + 42 +19 = 141

2. What is the total amount of period costs?

=> Period cost = Administrative cost + Selling cost = 22 + 35 = 57

3. What is the total amount of conversion costs?

=> Conversion cost = DL + MO = 42 + 19 = 61

4. What is the total amount of prime costs?

=> Prime cost = DM + DL = 80 + 42 = 122

E 2.3 CLASSIFICATION OF COSTS AS PERIOD OR PRODUCT COST [L02]

Suppose that you have been given a summer job as an intern at Issac Aircams, a
company that manufactures sophisticated spy cameras for remote-controlled
military reconnaissance aircraft. The company, which is privately owned, has
approached a bank for a loan to help it finance its growth. The bank requires
financial statements before approving such a loan. You have been asked to help
prepare the financial statements and were given the following list of costs:

1. Depreciation on salespersons' cars.

=> Period cost (Selling cost)

2. Rent on equipment used in the factory.

=> Product cost (MO)

3. Lubricants used for machine maintenance.

=> Product cost (MO)

4. Salaries of personnel who work in the finished goods warehouse.

=> Preriod cost ( Administrative cost)

5. Soap and paper towels used by factory workers at the end of a shift.

=> Product cost (MO)

6. Factory supervisors' salaries.

=> Product cost (MO)

7. Heat, water, and power consumed in the factory.

=> Product cost (MO)

8. Materials used for boxing products for shipment overseas. (Units are not
normally boxed.)

=> Period cost (Selling cost)

9. Advertising costs.

=> Period cost (Selling cost)

10. Workers' compensation insurance for factory employees.

=> Product cost (MO)

11. Depreciation on chairs and tables in the factory lunchroom.

=> Product cost (MO)

12. The wages of the receptionist in the administrative offices.

=> Preriod cost (Administrative cost)

13. The cost of leasing the corporate jet used by the company's executives.

=> Preriod cost (Administrative cost)

14. The cost of renting rooms at a Florida resort for the annual sales conference.

=> Preriod cost (Administrative cost)

15. The cost of packaging the company's product.

=> Product cost (MO)

Required:

Classify the above costs as either product costs or period costs for the purpose of
preparing the financial statements for the bank.

E 2.4 CONSTRUCTING AN INCOME STATEMENT [L03]

Last month CyberGames, a computer game retailer, had total sales of $1,450,000,
selling expenses of $210,000, and administrative expenses of $180,000. The
company had beginning merchandise inventory of $240,000, purchased
additional merchandise inventory for $950,000, and had ending merchandise
inventory of $170,000.

Required:

Prepare an income statement for the company for the month.

ANSWER

COGS = Beginning merchandise + Purchased – Ending merchandise

= 240 + 950 – 170 = 1020

CyberGames

Income statement

Sales $1,450,000

COGS $1,020,000
 Gross profit $430,000

Selling and Administrative expenses $390,000

Net income $40,000

E 2.5 PREPARE A SCHEDULE OF COST OF GOODS MANUFACTURED

[L04]

Lompac Products manufactures a variety of products in its factory. Data for the
most recent month's operations appear below:

Required:

Prepare a schedule of cost of goods manufactured for the company for the
month.

ANSWER

- DM: Beginning raw materials + Purchased raw materials – Ending raw materials

= 60 + 690 – 45 = 705

- DL: 135

- MO: 370

- Cost of goods manufactured = Total manufactured cost + Beginning WIP – Ending

WIP = (705 + 135 + 370) + 120 – 130 = 1200

E 2.6 CLASSIFICATION OF COSTS AS FIXED OR VARIABLE [L05]

Below are costs and measures of activity in a variety of organizations.

Required:
Classify each cost as variable or fixed with respect to the indicated measure of
activity by placing an X in the appropriate column:

ANSWER

- Variable cost: 1, 4, 6, 8, 9

- Fixed cost: 2, 3, 5, 7, 10

E 2.7 IDENTIFYING DIRECT AND INDIRECT COSTS [L06]

Northwest Hospital is a full-service hospital that provides everything from major

surgery and emergency room care to outpatient clinics.

Required:

For each cost incurred at Northwest Hospital, indicate whether it would most
likely be a direct cost or an indirect cost of the specified cost object by placing an
X in the appropriate column.
ANSWER

- Direct cost: 1, 2, 5, 7

- Indirect cost: 3, 4, 6

QUICK TEST

1. The management accountant of Retailer R has observed that one purchase ledger
clerk needs to be recruited for every 50 supplier accounts that need management and
administration. From the options below, choose the appropriate cost classification in
the above scenario.

a. Step cost

b. Mixed cost

c. Variable cost

d. Fixed cost

2. At an activity level of 8700 machine-hours in a month, Falks Corporation's total

variable production engineering cost is $728,190 and its total fixed production
engineering cost is $232,290. What would be the total production engineering cost per
machine-hour, both fixed and variable, at an activity level of 8900 machine-hours in a
month? Assume that this level of activity is within the relevant range. (Round
intermediate calculations to 2 decimal places.)

Select one:

A. $108.91

Β. $109.98

C. $109.80
D. $109.45

ANSWER

- Variable cost per machine-hour = 728190/8700 = 83.7

- Variable cost at 8900 machine hour = 83.7 * 8900 = 744930

- Total cost = Variable cost + Fixed cost = 744930 + 232290 = 977220

- Total production engineering cost per machine-hour = 977220/8900 = 109.8

3. During the month of January, direct labor cost totaled $17,000 and direct labor cost
was 60% of prime cost. If total manufacturing costs during January were $82,000, the
manufacturing overhead was:

a. $11,333

b. $65,000

c. $28,333

d. $53,667

ANSWER

- DL = 60% * (DM + DL) => DM = 11333.33

- Total manufacturing costs = DM + DL + MO => MO = 53666.67

4. Joel is the manager of Kay Ltd, a factory producing t-shirts. The factory has the
capacity to produce 7,000 t-shirts every week. The factory currently produces 4,000 t-
shirts every week.

Which of the following can be categorized as a direct cost for Kay Ltd?

a. Wages of factory workers engaged in machine maintenance

b. Cost of transporting raw materials from the supplier's premises

c. Cost of indirect production materials

d. Depreciation of lorries used for deliveries to customers

e. Property taxes on a company's factory building

5. Which of the following statements in regard to cost classifications is or are TRUE?

Select ALL that may apply:

a. Indirect labour for a factory will be labour working outside the factory
b. Depreciation is part of production overheads

c. Depreciation is a non-cash expense

d. Rent on a factory building used in the production process would be classified as a

period cost and as a fixed cost

e. The prime cost is the sum of all the production overheads

6. Which of the following statements in regard to cost behaviours is/are TRUE?

Select ALL that may apply:

a. Fixed costs remain constant in both the short-term and long run

b. Variable costs per unit are affected by changes in activity

c. Variable costs are constant in total when activity levels alter

d. Fixed costs are variable in the long run

7. Supervisors' salaries and computer services are among the costs incurred in a
factory. Costs expected at a range of activity levels are:

Which of the following classifications could describe the cost behaviour ?

ANSWER

- Supervisors' Salaries: Step-fixed cost (fixed within certain activity ranges but
increases in steps as activity exceeds certain thresholds)

- Computer services: Variable cost

8. Business X hires a machine which is used in the final packaging process in its
warehouse. A basic fixed monthly amount is paid for the machine with an additional
charge for each unit packaged. The number of units packaged varies from period to
period.

Which of the following is/are true about the cost of the machine hire to Business X?
Select ALL that apply.
The total cost per unit packaged will increase as packaging activity rises => FALSE

The total cost per unit packaged will decrease as packaging activity rises => TRUE

The total cost per unit packaged will vary from period to period => TRUE

9.