Calculating Cost

Value Chain

Value Chain Analysis

Technological Development

IN

Primary Activities

IN
G
M
AR

Outbound
Logistics
Marketing and
Sales
Service

Operations

Inbound Logistics

Procurement

Figure 4-4

Human Resource Management

G
AR
M

Primary
and
Support
Activities
in the
Value
Chain

Support
Activities

Firm Infrastructure

Cost Types
Product costs

Associated with the manufacture of goods or

the provision of services

Nonproduction costs

All other costs

Nonproduction Costs
Examples:

Designing

Distribution

Developing

Customer Service

General
Administration

Marketing

Nonproduction Costs
Examples:

These are Selling

Costs

Distribution

Customer Service

Marketing

Nonproduction Costs
Examples:

Designing

Developing

General
Administration

These are Administrative

Costs

Product Cost Classifications

Only three cost elements can be
assigned to products for financial
reporting:

Direct
Materials

Direct
Labor

Overhead

Direct Materials

Materials that are a part of the final

product and can be directly traced
to the goods and services being
produced.

Direct Labor

Labor that can be directly traced to

the goods or services being produced.

10

Overhead
All product costs other than direct
materials or direct labor.
Indirect
Materials

Supplies
Utilities

Indirect Labor

11

Total Product Cost

Total Product
=
Cost

Direct
+
Materials

Direct
+ Overhead
Labor

12

Product Cost Per Unit

Unit Cost

Total Product Cost

Number of Units
Produced
Lets work through an
example

13

Cornerstone 2-1
HOW TO Calculate Product Cost
in Total and Per Unit

Example
Information:
BlueDenim Company makes blue jeans.
Last week:

Direct Materials (denim, thread, zippers, and

rivets) costing $48,000 were put into production.

Direct labor of $30,000 (50 workers x 40 hours x

$15 per hour) was incurred.

Overhead equaled $72,000.

By the end of the week, the company had

manufactured 30,000 pairs of jeans.
15

Example
Required:
Calculate the total product cost for last week

Calculate the cost of one pair of jeans that

were produced last week.

Now that we know

what we have to do,
lets get started!
16

Total Product Cost

Direct Materials + Direct Labor + Overhead
Direct Materials
Direct Labor
Overhead
Total Product Cost

$48,000
30,000
72,000
$150,000

17

Per Unit Cost

Total Product Cost

Number of Units
Produced

$150,000
= $5 per pair
30,000
of jeans

18

Cornerstone 2-2
HOW TO Calculate Prime Cost
and Conversion Cost in Total and
Per Unit

Example
Information:
BlueDenim Company makes blue jeans.
Last week:

Direct Materials (denim, thread, zippers, and

rivets) costing $48,000 were put into production.

Direct labor of $30,000 (50 workers x 40 hours x

$15 per hour) was incurred.

Overhead equaled $72,000.

By the end of the week, the company had

manufactured 30,000 pairs of jeans.
20

Example
Required:
Calculate the total prime cost for last week

Calculate the per-unit prime cost

Calculate the total conversion cost for last

week

Calculate the per-unit conversion cost

Now that we know
what we have to do,
lets get started!
21

Prime Costs
Direct
Materials

Direct
Labor

$48,000

$30,000

Prime Costs
=
per unit

$78,000
30,000

$2.60

Units produced
22

Conversion Costs

Direct Labor + Overhead

It is the cost of converting raw
materials into a final product.

23

Conversion Costs
Direct Labor + Overhead
$30,000

+ $72,000

Conversion
= $102,000
Costs per unit
30,000

$3.40

Units produced
24

Period Costs
Unlike product costs which are
carried in inventory; period costs are
expensed in the period in which they
are incurred.

Two categories of period

costs: Selling Costs and
Administrative Costs.
25

Selling Costs

Costs necessary to market, distribute, and

service a product or service.
Examples:
Salaries and
commissions of
sales people

Advertising

Warehousing
Customer
Service

Shipping
26

Administrative Costs
All costs associated with research,
development, and general administration of
the organization that cannot reasonably be
assigned to either selling or production.
Examples:
Top Executive Salaries
General
Accounting

Legal Fees
Expenses of printing
the annual report
27

Objective # 3

Prepare income statements for

manufacturing and service
organizations.

28

Cost of Goods Manufactured

Total product cost of goods
completed during the current period
Direct Materials
+ Direct Labor
+ Overhead

Sounds simple enough.

But theres more to it than
meets the eye.

29

Direct Materials Used

Only the amount used on products

produced during the current period

Consider beginning and ending inventory

levels

Key point: Purchases do not equal

Materials Used

Lets go through an
example.
30

Cornerstone 2-3

HOW TO Calculate the Direct

Materials Used in Production

Example
Information:
BlueDenim Company makes blue jeans.

On May 1, BlueDenim had $68,000 of

materials in inventory.

During the month of May, the company

purchased $210,000 of materials.

On May 31, materials inventory equaled

$22,000.

32

Example
Required:
Calculate the direct materials used in
production for the month of May

33

Direct Materials

Beginning
Ending
Materials
Materials + Purchases - Materials = Used in
Inventory
Inventory
Production

$68,000

+ $210,000

-$22,000

=$256,000

34

Work in Process

Second type of inventory

Cost of partially completed goods that are still

on the factory floor at the end of the period

Units are started, but not finished

Included direct materials, direct labor, and

overhead costs
Lets continue our
example
35

Cornerstone 2-4

HOW TO Calculate Cost of Goods

Manufactured

Example
Information:
BlueDenim Company makes blue jeans.

During the month of May, the company

purchased $210,000 of materials.

On May 31, materials inventory equaled

$22,000.

During the month of May, BlueDenim

Company incurred:

Direct labor cost of $135,000

Overhead of $150,000
37

Example
Information continued:
Inventory information is as follows:
May 1 May 31
Materials
$68,000 $22,000
Work in Process
50,000
16,000

38

Example
Required:
Calculate the cost of goods manufactured
for the month of May.
Calculate the cost of one pair of jeans
assuming that 115,000 pairs of jeans were
completed during May.

39

Cost of Goods
Manufactured
Direct Materials
$256,000*
Direct Labor
135,000
Overhead
150,000
Total Manufacturing Cost
$541,000
Work in Process, May 1
50,000
Work in Process, May 31
( 16,000)
Cost of Goods Manufactured $575,000
Per unit Cost of
Goods Manufactured
*Calculated in Cornerstone 2-3

$575,000 = $5
115,000 units
40

Cornerstone 2-5

HOW TO Calculate Cost of Goods

Sold

Example
Information:

On May 1 BlueDenim Company had 10,000

units in finished goods inventory costing
$50,000

On May 31 the company had 26,000 units in

finished goods inventory costing $130,000

42

Example
Required:

Calculate the cost of goods sold for the

month of May.

Calculate the number of pairs of jeans that

were sold during May.

43

Cost of Goods Sold

Represents the total cost of units sold during

a period

Includes only product cost

Included direct materials, direct labor, and

overhead

Reported as an expense on the income

statement
Sold is the key word.
Lets continue with our
example
44

Cost of Goods Sold

Cost of good manufactured

Finished goods, May 1
Finished goods, May 31
Cost of Goods Sold

$575,000
50,000
(130,000)
$495,000

Reported as an expense on
the Income Statement
45

Cost of Goods Sold

Cost of good manufactured

Finished goods, May 1
Finished goods, May 31
Cost of Goods Sold

$575,000
50,000
(130,000)
$495,000

Reported as an asset on the

Balance Sheet
46

Units Sold
Number of units sold:
Finished goods inventory, May 1
Units finished during May
Finished goods inventory, May 31
Units sold during May

10,000
115,000
(26,000)
99,000

47

Cornerstone 2-6
HOW TO Prepare an
Income Statement for a Manufacturing
Firm

Example
Information:

BlueDenim Company sold 99,000 pairs of

jeans during the month of May at a total cost
of $495,000.

Each pair sold at a price of $8.

Blue Denim also incurred two types of selling

costs:

Commissions equal to 10% of the sales price

Other selling expense of $120,000.

Administrative expense totaled $85,000

49

Example
Required:
Prepare an income statement for BlueDenim
for the month of May

50

BlueDenim Company
Income Statement
For the Month of May
Sales revenue

$792,000

99,000 rockers x $8

51

BlueDenim Company
Income Statement
For the Month of May
Sales revenue
Cost of goods sold
Gross margin

$792,000
495,000
$297,000

Gross Margin is the difference

between sales revenue and
cost of goods sold.
52

BlueDenim Company
Income Statement
For the Month of May
Sales revenue
Cost of goods sold
Gross margin
Less:
Selling expense:
Commissions
$ 79,200
Fixed selling expense
120,000
Administrative expense
$792,000 x 10%
Operating income

$792,000
495,000
$297,000

199,200
85,000
$ 12,800
53

Cornerstone 2-7
HOW TO Calculate the Percentage of
Sales Revenue for Each Line on the
Income Statement

BlueDenim Company
Income Statement
For the Month of May

%
$792,000 100.0
495,000
$297,000

Sales revenue
Cost of goods sold
Gross margin
Less:
Selling expense:
by Sales
CommissionsEach item is divided
$ 79,200
revenue. For
example, 199,200
Fixed selling expense
120,200
$792,000/$792,000 = 100% 85,000
Administrative expense
Operating income
$ 12,800
55

BlueDenim Company
Income Statement
For the Month of May

%
Sales revenue
$792,000 100.0
Cost of goods sold
495,000 62.5
Gross margin
$297,000
Less:
$495,000/$792,000 = 62.5%
Selling expense:
Commissions
$ 79,200
Fixed selling expense
120,200
199,200
85,000
Administrative expense
Operating income
$ 12,800
56

BlueDenim Company
Income Statement
For the Month of May

%
$792,000 100.0
495,000 62.5
$297,000 37.5

Sales revenue
Cost of goods sold
Gross margin
Less:
Selling expense: How would an Income
a service
Commissions Statement $for
79,200
business be different
than this
Fixed selling expense
120,000
199,200
Income Statement?
85,000
Administrative expense
Operating income
$ 12,800
57

25.2
10.7
1.6

Cornerstone 2-8
HOW TO Prepare an Income
Statement for a Service
Organization

Example
Information:
Komala Information Systems designs and
installs software for small companies.
Last month, Komala had costs of:

Materials, $5,000

Direct labor, $35,000

Overhead, $55,000

Selling expenses, $5,000

Administrative expenses, $7,000

Sales totaled $130,000

59

Example
Required:
Prepare an income statement for Komala
Information Systems for the past for the
month.

60

Income Statement:
Service Organization
Cost of services sold is typically made up of:

Materials

Labor

Overhead

No beginning or ending finished goods

inventories.

Cost of Services Sold will always equal Cost

of Services Manufactured.

61

Komala Information Systems

Income Statement
For the Past Month
Sales
Cost of services sold
Direct materials
Direct labor
Overhead
Gross margin
Less:
Selling expense
Administrative expense
Operating income

$130,000
$ 5,000
35,000
55,000

95,000
$ 35,000
5,000
7,000
$ 23,000
62