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Chapter 2

RSM222H1 Chapter Notes - Chapter 2: Opportunity Cost, Variable Cost, Financial Statement

Rotman Commerce
Course Code
Christian Campbell

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Chapter 2: Cost Terms, Concepts, and Classifications
Purpose of Cost Classification Cost Classifications
Preparing external financial statementsProduct costs (inventoriable):
Period Costs (expensed):
-selling & administrative costs
Predicting cost behaviour in response
to changes in activity
-Variable cost
-Fixed Cost
Assigning costs to cost objects such
as departments or products
-Direct cost (can easily be traced)
-Indirect cost (constant in total)
Making decisions-Differential cost (differs b/w alternatives)
-Sunk Cost (past cost not affected by a decision)
-Opportunity cost (forgone benefit)
General Cost Classifications
1.Manufacturing Costs
-Direct Materials: those materials that become an integral part of a finished product and can be
conveniently traced to it
raw materials: any materials that go into the final product, and the finished product of one company can
become the raw materials of another company
-Direct Labour (touch labour): those factory labour costs that can be traced easily to individual units of
in some industries, sophisticated automated equipment, operated and maintained by skilled indirect
workers, is increasingly replacing direct labour. in a few companies, DL has become such a minor element
of cost that it has disappeared altogether as a separate cost category
-Manufacturing Overhead: all costs associated with manufacturing except direct materials and direct
only those costs other than DM and DL that are associated w/ operating the factory or production facility
are included in the MOH category
indirect materials: small items of material such as glue and nails. These items may become an integral
part of a finished product but are traceable to the product only at great cost or inconvenience
indirect labour: the labour costs of factory workers that cannot be conveniently traced directly to particular
products (e.g. wages of janitors)
MOH+DL= Conversion Cost
DM + DL = Prime Cost
2. Classification of Idle Time, Overtime Premiums and Employee Benefits
-Idle Time:
idle time cost usually would be charged to overhead if management felt that the cost was a general cost of
all production
if a specific job required idle time, then the idle time could be charged to the DL costs of a job
-Overtime Premiums:
classification depends on the cause of the overtime
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a job-specific reason would dictate a direct job cost
normal overtime cost resulting from general mgt decisions would dictate an overhead charge to all jobs
-Employee Benefits:
employee benefits costs for indirect labour would obviously be classified as indirect overhead
employee benefits for direct labour could justifiably be added to the base direct labour rate to specifically
follow the direct labour costs on which they are based
3. Non-Manufacturing Costs
Marketing or Selling Costs (order-getting / order-filling costs): all costs necessary to secure customer
orders and get the finished product or service into the hands of the customer
Administrative Costs: all executive, organizational, and clerical management of an organization rather
than with manufacturing, marketing, or selling
Product Costs vs. Period Costs
-costs can also be classified as either product costs or period costs
1.Product Costs (or inventoriable costs): all costs that are involved in the purchase or manufacture of
goods. In the case of manufactured goods, these costs consist of DM, DL, and MOH
-initially, product costs are assigned to an inventory account on the balance sheet. When the goods are
sold, the costs are released from inventory as expenses (typically called GOCS) and matched against sales
-A product cost might be incurred during one period but not treated as an expense until a following period
when the completed product is sold.
2.Period Costs: costs that are taken directly to the income statement as expenses in the period in which
they are incurred or accrued; such costs consist of selling and administrative expenses (e.g. advertising,
executive salaries, etc.)
Cost Classifications on Financial Statements
1. Balance Sheet
-merchandising company has only one class of inventory: merchandise inventory
-manufacturing companies have three classes of inventories: raw materials, work in process, and finished
2. Income Statement
Basic Equation for Inventory Accounts
Beg. Balance + Additions to Inventory = Ending Balance + Withdrawals from inventory
a) Cost of Goods Sold in a Merchandising Company
Beg. Balance inventory + Purchases = Ending merchandising inventory+ COGS
COGS= Beg. merchandise inventory + Purchases - Ending merchandise inventory
b) Cost of Goods Sold in a Manufacturing Company
Beg. finished goods inventory + Cost of goods manufactured = Ending finished goods inventory + COGS
COGS = Beg. finished goods inventory + Cost of goods manufactured - Ending finished goods inventory
Schedule of Cost of Goods Manufactured
-Cost of goods manufactured: the manufacturing costs associated w/ the goods that were finished during
the period
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