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Chapter 2

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York University
ACTG 2020
Ben Kelly

ACTG2020 Chapter 2 Jessica Gahtan CHAPTER 2: COST TERMS, CONCEPTS, AND CLASSIFICATIONS GENERAL COST CLASSIFICATIONS MANUFACTURING Direct Materials Direct materials are those materials that become an integral part of a finished product and can be conveniently traced to it - Raw materials (= any materials used in the final product, and the finished product of one company can be the raw materials of another; includes direct and indirect materials) Indirect materials are small items of material such as glue and nails that may become an integral part of a finished product but the costs of tracing them exceed the benefits Direct Labour Direct labour is that factory labour costs that can be traced easily to individual units of product- also called touch labor Indirect labour is the labor costs of janitors, supervisors, materials for handlers, and other factory workers that can’t be conveniently traced directly to particular products Manufacturing Overhead Manufacturing overhead (aka indirect manufacturing cost, factory overhead, factory burden) all costs associated with manufacturing except direct materials and direct labour; includes items like indirect materials, indirect labour, maintenance and repairs on production equipment, head and lighting, property taxes, depreciation, insurance on manufacturing facilities Conversion cost = Direct labour + manufacturing overhead Prime cost = Direct materials + direct labour - Proportion of labour to overhead varies from company to company and even across companies within the same industry - How orgs determine their relative proportions of materials, direct labor, and overhead is a significant component of strategic cost management CLASSIFICATION OF LABOR COSTS OF MANUFACTURING - Classifying direct and indirect labor costs is pretty straightforward - More difficult to appropriately classify idle time and overtime premiums of production workers Overtime premium is the extra hourly wage rate paid to workers who must work above their normal time requirements - Classification of the overtime as direct labor or overhead depends on the cause of the overtime- a job-specific reason (e.g., a rush order) would dictate a direct job cost; a normal overtime cost resulting from general conditions (i.e. peak production needs) would dictate an overhead (indirect) charge to all jobs completed during that period NON-MANUFACTURING COSTS Marketing or selling costs (aka order-getting and order-filling costs) are all costs necessary to secure customer orders, and get the finished product or service to the customer - Order-getting examples: advertising, sales travel and sales salaries - Order-filling cost examples: shipping, sales commissions, costs of finished goods warehouses Administrative costs are all executive, organizational, and clerical costs associated with the general management of an org rather than with marketing, manufacturing or selling - Executive compensation, accounting, secretarial, public relations, and similar costs involved in the overall, general administration of the org as a whole - Service orgs are making increased use of cost concepts in analyzing and costing their services 1 ACTG2020 Chapter 2 Jessica Gahtan PRODUCT COSTS VS. PERIOD COSTS - The matching principle is based on the accrual concept and states that costs incurred to generate a particular revenue should be recognized in the same period that the revenue is recognized PRODUCT COSTS Product costs (or Inventoriable costs) are all costs that are involved in the purchase or manufacture of goods- in the case of manufactured goods, these costs consist of direct materials, direct labour, and manufacturing overhead - They ‘attach’ to units of product - Product costs aren’t necessarily treated as expenses in the period in which they’re incurred- they’re treated as expenses in the period in which the related products are sold PERIOD COSTS Period costs are those costs that are taken directly to the I/S as expenses in the period in which they’re incurred or accrued; such costs consist of selling (marketing) and administrative expenses - Like advertising, executive salaries, public relations, other non-manufacturing costs - Careful analysis of the purpose of a cost- necessary to separate period and product costs COST CLASSIFICATIONS ON FINANCIAL STATEMENTS - The production process in a manufacturing company makes their financial statements more complex than those of merchandising companies THE BALANCE SHEET - Or statement of financial position - There are differences in the inventory accounts (between manufacturing and merchandising companies) - Merchandising company- one class of inventory- goods purchased from suppliers that are awaiting resale - Manufacturing company- 3 class- raw (direct) materials, work-in-progress, finished goods - Typically only the sum of the 3 categories of inventory is shown on the b/s of external reports- however, footnotes to the f/s often provide more detail about the amounts in each category THE INCOME STATEMENT Basic equation for inventory accounts: Beginning Balance+Additions¿inventory=endingbalance+withdrawals¿inventory Cost of Goods Sold in a Merchandising Company: Beginningbalanceinventory+purchases=endingmerchandiseinventory+costof goodssold OR Cost of Goodssold=beginningmer
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