CHAPTER 2
BASIC COST MANAGEMENT CONCEPTS
DISCUSSION QUESTIONS
1. An accounting information system is a sys- 8. Traceability is the ability to assign a cost di-
tem consisting of interrelated manual and rectly to a cost object in an economically fea-
computer parts, using processes such as col- sible way using physical observation or a
lecting, recording, classifying, summarizing, causal relationship.
analyzing, and managing data to provide out-
9. Allocation is the assignment of indirect costs
put information to users.
to cost objects based on convenience or as-
2. The financial accounting information system sumed linkages.
is primarily concerned with producing outputs
10. Driver tracing uses drivers based on a causal
for external users using well-specified eco-
relationship to trace costs to cost objects.
nomic events as inputs and processes that
meet certain rules. The cost management Often, this means that costs are first traced to
activities using resource drivers and then to
system, on the other hand, produces outputs
cost objects using activity drivers.
for internal users, and the criteria that govern
inputs and processes are directly related to 11. Tangible products are goods that are made by
management objectives. As a result, the cost converting raw materials into a final product
management system is more flexible than the through the use of labor and capital inputs.
financial system.
12. A service is a task or activity performed for a
3. The three broad objectives of a cost manage- customer or an activity performed by a cus-
ment information system are: (1) to cost out tomer using an organization’s products or fa-
products, services, and other cost objects; (2) cilities. Services differ from tangible products
to provide information for planning and con- on three important dimensions: intangibility,
trol; and (3) to provide information for deci- perishability, and inseparability. Intangibility
sion making. means that buyers of services cannot see,
feel, taste, or hear a service before it is bought.
4. The cost accounting information system is a
Perishability means that services cannot be
cost management subsystem designed to as-
sign costs to products, services, and other stored. Inseparability means that producers of
services and buyers of services must be in di-
objects as management needs specify. The
rect contact (not true for tangible products).
operational control information system is a
cost management information subsystem de- 13. Three examples of product cost definitions are
signed to provide accurate and timely feed- value-chain, operating, and traditional defini-
back concerning the performance of tions. The value-chain definition includes cost
managers and others relative to their plan- assignments for research and development,
ning and control of activities. production, marketing, and customer service
(all value-chain activities). Operational product
5. A cost object is anything for which costs are
measured and assigned. Examples include: costs include all costs except for research and
development. Traditional product costs include
activities, products, plants, and projects.
only production costs. Different costs are
6. An activity is a basic unit of work performed needed because they serve different manage-
within an organization. Examples include ma- rial objectives.
terials handling, inspection, purchasing, bill-
14. The three cost elements are direct materials,
ing, and maintenance.
direct labor, and overhead.
7. A direct cost is a cost that can be easily and
15. The income statement for a service firm does
accurately traced to a cost object. An indirect
not need a supporting cost of goods manu-
cost is a cost that cannot be easily and accu-
rately traced to cost objects. factured schedule. Since services cannot be
stored, the cost of services produced equals
the cost of services sold (not necessarily true
for a manufacturing firm).
2-1
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
, CORNERSTONE EXERCISES
Cornerstone Exercise 2.1
1. Unit prime cost
= (Direct materials + Direct labor)/Units
= ($120,000 + $60,000)/50,000
= $3.60
2. Unit conversion cost
= (Direct labor + Variable overhead + Fixed overhead)/Units
= ($60,000 + $25,000 + $220,000)/50,000
= $6.10
3. Unit variable product cost
= (Direct materials + Direct labor + Variable overhead)/Units
= ($120,000 + $60,000 + $25,000)/50,000
= $4.10
4. Unit product cost
= (Direct materials + Direct labor + Variable overhead + Fixed overhead)/Units
= ($120,000 + $60,000 + $25,000 + $220,000)/50,000
= $8.50
5. Total direct materials, total direct labor, and total variable overhead would all in-
crease by 10 percent since the units increased by 10 percent and these are
strictly variable costs. Total fixed overhead would remain the same. Unit prime
cost would increase by 10 percent since both direct materials and direct labor
are strictly variable, and 10 percent more units would require 10 percent more
variable cost. However, unit conversion cost would increase by less than 10 per-
cent because of the presence of fixed costs.
New unit product cost
= [($120,000 + $60,000 + $25,000)(1.10) + $220,000)]/55,000
= $8.10
2-2
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
,Cornerstone Exercise 2.2
1. Pietro Frozen Foods, Inc.
Statement of Cost of Goods Manufactured
For the Coming Year
Direct materials
Beginning inventory .................................................. $ 5,600
Add: Purchases ......................................................... 119,300
Materials available ..................................................... $ 124,900
Less: Ending inventory ............................................. 4,900
Direct materials used in production .............................. $ 120,000
Direct labor ...................................................................... 60,000
Manufacturing (Factory) overhead ................................ 245,000
Total manufacturing costs added.................................. $ 425,000
Add: Beginning work in process ................................... 12,500
Less: Ending work in process ....................................... 14,600
Cost of goods manufactured ......................................... $ 422,900
2. If the ending inventory of direct materials were $2,000 higher, then the direct
materials used in production would be $2,000 smaller, the total manufacturing
costs added would be $2,000 lower, and the cost of goods manufactured would
be $2,000 lower. No other line items would be affected.
Cornerstone Exercise 2.3
1. Pietro Manufacturing, Inc.
Statement of Cost of Goods Sold
For the Coming Year
Cost of goods manufactured ............................................................... $422,900
Add: Beginning finished goods ........................................................... 42,500
Cost of goods available for sale .......................................................... $465,400
Less: Ending finished goods ............................................................... 34,000
Cost of goods sold ............................................................................... $431,400
2. If beginning finished goods were $5,000 lower, then the cost of goods sold
would be $5,000 lower.
2-3
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
, Cornerstone Exercise 2.4
Pietro Manufacturing, Inc.
Income Statement
For the Coming Year
Percent
Sales ($12.50 × 49,300) .............................. $ 616,250 100.00
Cost of goods sold .................................... 431,400 70.00
Gross margin ............................................. $ 184,850 30.00
Less operating expenses:
Selling expenses .................................. $ 26,000
Administrative expenses ..................... 134,000 160,000 25.96
Operating income ...................................... $ 24,850 4.03
2. If the cost of goods sold has been 65 percent of sales for the past few years,
managers would probably be concerned. Cost of goods sold has risen by 5%,
and profit has probably declined. Managers should investigate to see why the
increase occurred, and take steps to decrease product costs or increase price,
if possible, in the coming year.
Cornerstone Exercise 2.5
1. Unit prime cost
= (Direct materials + Direct labor)/Units
= ($27,000 + $472,500)/15,000
= $33.30
2. Unit conversion cost
= (Direct labor + Variable overhead + Fixed overhead)/Units
= ($472,500 + $15,000 + $18,000)/15,000
= $33.70
3. Unit variable services production cost
= (Direct materials + Direct labor + Variable overhead)/Units
= ($27,000 + $472,500 + $15,000)/15,000
= $34.30
4. Unit services production cost
= (Direct materials + Direct labor + Variable overhead + Fixed overhead)/Units
= ($27,000 + $472,500 + $15,000 + $18,000)/15,000
= $35.50
2-4
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
BASIC COST MANAGEMENT CONCEPTS
DISCUSSION QUESTIONS
1. An accounting information system is a sys- 8. Traceability is the ability to assign a cost di-
tem consisting of interrelated manual and rectly to a cost object in an economically fea-
computer parts, using processes such as col- sible way using physical observation or a
lecting, recording, classifying, summarizing, causal relationship.
analyzing, and managing data to provide out-
9. Allocation is the assignment of indirect costs
put information to users.
to cost objects based on convenience or as-
2. The financial accounting information system sumed linkages.
is primarily concerned with producing outputs
10. Driver tracing uses drivers based on a causal
for external users using well-specified eco-
relationship to trace costs to cost objects.
nomic events as inputs and processes that
meet certain rules. The cost management Often, this means that costs are first traced to
activities using resource drivers and then to
system, on the other hand, produces outputs
cost objects using activity drivers.
for internal users, and the criteria that govern
inputs and processes are directly related to 11. Tangible products are goods that are made by
management objectives. As a result, the cost converting raw materials into a final product
management system is more flexible than the through the use of labor and capital inputs.
financial system.
12. A service is a task or activity performed for a
3. The three broad objectives of a cost manage- customer or an activity performed by a cus-
ment information system are: (1) to cost out tomer using an organization’s products or fa-
products, services, and other cost objects; (2) cilities. Services differ from tangible products
to provide information for planning and con- on three important dimensions: intangibility,
trol; and (3) to provide information for deci- perishability, and inseparability. Intangibility
sion making. means that buyers of services cannot see,
feel, taste, or hear a service before it is bought.
4. The cost accounting information system is a
Perishability means that services cannot be
cost management subsystem designed to as-
sign costs to products, services, and other stored. Inseparability means that producers of
services and buyers of services must be in di-
objects as management needs specify. The
rect contact (not true for tangible products).
operational control information system is a
cost management information subsystem de- 13. Three examples of product cost definitions are
signed to provide accurate and timely feed- value-chain, operating, and traditional defini-
back concerning the performance of tions. The value-chain definition includes cost
managers and others relative to their plan- assignments for research and development,
ning and control of activities. production, marketing, and customer service
(all value-chain activities). Operational product
5. A cost object is anything for which costs are
measured and assigned. Examples include: costs include all costs except for research and
development. Traditional product costs include
activities, products, plants, and projects.
only production costs. Different costs are
6. An activity is a basic unit of work performed needed because they serve different manage-
within an organization. Examples include ma- rial objectives.
terials handling, inspection, purchasing, bill-
14. The three cost elements are direct materials,
ing, and maintenance.
direct labor, and overhead.
7. A direct cost is a cost that can be easily and
15. The income statement for a service firm does
accurately traced to a cost object. An indirect
not need a supporting cost of goods manu-
cost is a cost that cannot be easily and accu-
rately traced to cost objects. factured schedule. Since services cannot be
stored, the cost of services produced equals
the cost of services sold (not necessarily true
for a manufacturing firm).
2-1
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
, CORNERSTONE EXERCISES
Cornerstone Exercise 2.1
1. Unit prime cost
= (Direct materials + Direct labor)/Units
= ($120,000 + $60,000)/50,000
= $3.60
2. Unit conversion cost
= (Direct labor + Variable overhead + Fixed overhead)/Units
= ($60,000 + $25,000 + $220,000)/50,000
= $6.10
3. Unit variable product cost
= (Direct materials + Direct labor + Variable overhead)/Units
= ($120,000 + $60,000 + $25,000)/50,000
= $4.10
4. Unit product cost
= (Direct materials + Direct labor + Variable overhead + Fixed overhead)/Units
= ($120,000 + $60,000 + $25,000 + $220,000)/50,000
= $8.50
5. Total direct materials, total direct labor, and total variable overhead would all in-
crease by 10 percent since the units increased by 10 percent and these are
strictly variable costs. Total fixed overhead would remain the same. Unit prime
cost would increase by 10 percent since both direct materials and direct labor
are strictly variable, and 10 percent more units would require 10 percent more
variable cost. However, unit conversion cost would increase by less than 10 per-
cent because of the presence of fixed costs.
New unit product cost
= [($120,000 + $60,000 + $25,000)(1.10) + $220,000)]/55,000
= $8.10
2-2
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
,Cornerstone Exercise 2.2
1. Pietro Frozen Foods, Inc.
Statement of Cost of Goods Manufactured
For the Coming Year
Direct materials
Beginning inventory .................................................. $ 5,600
Add: Purchases ......................................................... 119,300
Materials available ..................................................... $ 124,900
Less: Ending inventory ............................................. 4,900
Direct materials used in production .............................. $ 120,000
Direct labor ...................................................................... 60,000
Manufacturing (Factory) overhead ................................ 245,000
Total manufacturing costs added.................................. $ 425,000
Add: Beginning work in process ................................... 12,500
Less: Ending work in process ....................................... 14,600
Cost of goods manufactured ......................................... $ 422,900
2. If the ending inventory of direct materials were $2,000 higher, then the direct
materials used in production would be $2,000 smaller, the total manufacturing
costs added would be $2,000 lower, and the cost of goods manufactured would
be $2,000 lower. No other line items would be affected.
Cornerstone Exercise 2.3
1. Pietro Manufacturing, Inc.
Statement of Cost of Goods Sold
For the Coming Year
Cost of goods manufactured ............................................................... $422,900
Add: Beginning finished goods ........................................................... 42,500
Cost of goods available for sale .......................................................... $465,400
Less: Ending finished goods ............................................................... 34,000
Cost of goods sold ............................................................................... $431,400
2. If beginning finished goods were $5,000 lower, then the cost of goods sold
would be $5,000 lower.
2-3
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
, Cornerstone Exercise 2.4
Pietro Manufacturing, Inc.
Income Statement
For the Coming Year
Percent
Sales ($12.50 × 49,300) .............................. $ 616,250 100.00
Cost of goods sold .................................... 431,400 70.00
Gross margin ............................................. $ 184,850 30.00
Less operating expenses:
Selling expenses .................................. $ 26,000
Administrative expenses ..................... 134,000 160,000 25.96
Operating income ...................................... $ 24,850 4.03
2. If the cost of goods sold has been 65 percent of sales for the past few years,
managers would probably be concerned. Cost of goods sold has risen by 5%,
and profit has probably declined. Managers should investigate to see why the
increase occurred, and take steps to decrease product costs or increase price,
if possible, in the coming year.
Cornerstone Exercise 2.5
1. Unit prime cost
= (Direct materials + Direct labor)/Units
= ($27,000 + $472,500)/15,000
= $33.30
2. Unit conversion cost
= (Direct labor + Variable overhead + Fixed overhead)/Units
= ($472,500 + $15,000 + $18,000)/15,000
= $33.70
3. Unit variable services production cost
= (Direct materials + Direct labor + Variable overhead)/Units
= ($27,000 + $472,500 + $15,000)/15,000
= $34.30
4. Unit services production cost
= (Direct materials + Direct labor + Variable overhead + Fixed overhead)/Units
= ($27,000 + $472,500 + $15,000 + $18,000)/15,000
= $35.50
2-4
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
