Industrial Management

IPE 481

Tanveer Hossain Bhuiyan

Assistant Professor, Dept. of IPE
BUET

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Course Outline
Cost management elements
Management accounting:
Marginal costing & Standard costing
Budget & budgetary control
Cost planning & control

Industrial and Business Management

Leadership
Motivational Theories

Quantitative Decision Making

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Chapter 2

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Costs Terms, Concepts and

Classifications
Chapter Two

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Manufacturing Costs

Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

Manufacturing
Manufacturing
Overhead
Overhead

The Product

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Direct Materials
Raw materials that become an integral part of the
product and that can be conveniently traced
directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile

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Direct Labor
Those labor costs that can be easily traced to
individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers

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Manufacturing Overhead
Manufacturing costs that cannot be traced directly
to specific units produced.
Examples:
Examples: Indirect
Indirect labor
labor and
and indirect
indirect materials
materials
Wages paid to employees
who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.

McGrawHill/Irwin

Materials used to support

the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.

Copyright2006,TheMcGrawHillCompanies,Inc.

Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct
Direct
Material
Material

Direct
Direct
Labor
Labor

Prime
Cost

McGrawHill/Irwin

Manufacturing
Manufacturing
Overhead
Overhead

Conversion
Cost

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Non-manufacturing Costs

Marketing or
Selling Cost

Administrative
Cost

Costs necessary to get

the order and deliver
the product.

All executive,
organizational, and
clerical costs.

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Product Costs Versus Period Costs

Product costs include

direct materials, direct
labor, and manufacturing
overhead.
Inventory

Cost of Good Sold

Period costs include all

marketing or selling
costs and
administrative costs.
Expense

Sale

Balance
Sheet
McGrawHill/Irwin

Income
Statement

Income
Statement
Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Which of the following costs would be considered a
period rather than a product cost in a manufacturing
company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.

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Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Which of the following costs would be considered a
period rather than a product cost in a manufacturing
company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.

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Comparing Merchandising and

Manufacturing Activities
Merchandisers . . .
Buy finished goods.
Sell finished goods.

Manufacturers . . .
Buy raw materials.
Produce and sell
finished goods.

MegaLoMart

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Balance Sheet
Merchandiser
Current assets

Manufacturer
Current Assets

Cash

Cash

Receivables

Receivables

Prepaid Expenses
Merchandise

Inventory

McGrawHill/Irwin

Prepaid Expenses
Inventories
Raw Materials
Work in Process
Finished Goods

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Balance Sheet
Merchandiser
Current assets

Manufacturer
Current Assets

Cash

Cash

Receivables

Receivables
Materials
waiting to
be processed.
Prepaid
Expenses

Prepaid Expenses

Partially complete
products some
Inventory
material, labor, or
overhead has been
added.

Merchandise

Inventories
Raw Materials
Work in Process
Finished Goods

Completed products
awaiting sale.
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The Income Statement

Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for merchandisers.
Merchandising Company
Cost of goods sold:
Beg. merchandise
inventory
+ Purchases
Goods available
for sale
- Ending
merchandise
inventory
= Cost of goods
sold

McGrawHill/Irwin

$ 14,200
234,150
$ 248,350

(12,100)
$ 236,250

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Inventory Flows
Beginning
Beginning
balance
balance
$$
$$

Available
Available
$$$$$
$$$$$

McGrawHill/Irwin

Additions
Additions
$$$
$$$

_ Withdrawals
Withdrawals
$$$
$$$

Available
Available
$$$$$
$$$$$

Ending
Ending
balance
balance
$$
$$

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
If your inventory balance at the beginning of the
month was $1,000, you bought $100 during the
month, and sold $300 during the month, what would
be the balance at the end of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.

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Quick Check
If your inventory balance at the beginning of the
month was $1,000, you bought $100 during the
month, and sold $300 during the month, what would
be the balance at the end of the month?
A. $1,000.
$1,000 + $100 = $1,100
B. $ 800.
$1,100 - $300 = $800
C. $1,200.
D. $ 200.

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Schedule of Cost of Goods

Manufactured
Calculates the cost of raw
material, direct labor and
manufacturing overhead used
in production.

Calculates the manufacturing

costs associated with goods
that were finished during the
period.
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Product Cost Flows

Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

McGrawHill/Irwin

Manufacturing
Costs

Work
In Process

Direct materials

As
Asitems
itemsare
areremoved
removed from
from raw
raw
materials
materialsinventory
inventoryand
and placed
placedinto
into
the
theproduction
productionprocess,
process, they
theyare
are
called
called direct
direct materials.
materials.
Copyright2006,TheMcGrawHillCompanies,Inc.

Product Cost Flows

Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

McGrawHill/Irwin

Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

Work
In Process

Conversion
Conversion
costs
costsare
arecosts
costs
incurred
incurredto
to
convert
convert the
the
direct
directmaterial
material
into
into aafinished
finished
product.
product.

Copyright2006,TheMcGrawHillCompanies,Inc.

Product Cost Flows

Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

McGrawHill/Irwin

Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

Work
In Process
Beginning work in
process inventory
+ Total manufacturing
costs
= Total work in
process for the
period

All
All manufacturing
manufacturing costs
costsincurred
incurred
during
during the
theperiod
period are
areadded
addedto
tothe
the
beginning
beginningbalance
balanceof
of work
workin
in
process.
process.
Copyright2006,TheMcGrawHillCompanies,Inc.

Product Cost Flows

Raw Materials
Beginning raw
materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production

Manufacturing
Costs

Work
In Process

Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

Beginning work in
process inventory
Total manufacturing
costs
Total work in
process for the
period
Ending work in
process inventory
Cost of goods
manufactured

+
=

Costs
Costsassociated
associated with
with the
thegoods
goodsthat
that
are
arecompleted
completedduring
duringthe
the period
period are
are
transferred
transferredto
tofinished
finished goods
goods
inventory.
inventory.
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Product Cost Flows

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Manufacturing Cost Flows

Costs

Balance Sheet
Inventories

Material Purchases

Raw Materials

Direct Labor

Work in
Process

Manufacturing
Overhead

Selling and
Administrative
McGrawHill/Irwin

Finished
Goods

Period Costs

Income
Statement
Expenses

Cost of
Goods
Sold
Selling and
Administrative
Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material used?

A.
B.
C.
D.

McGrawHill/Irwin

$276,000
$272,000
$280,000
$ 2,000

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material used?

A.
B.
C.
D.

McGrawHill/Irwin

$276,000
$272,000
$280,000
$ 2,000

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?

A.
B.
C.
D.
McGrawHill/Irwin

$555,000
$835,000
$655,000
Cannot be determined.
Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?

A.
B.
C.
D.
McGrawHill/Irwin

$555,000
$835,000
$655,000
Cannot be determined.
Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work
in process inventory at the end of the
month. What was the cost of goods
manufactured during the month?

A.
B.
C.
D.

McGrawHill/Irwin

$1,160,000
$ 910,000
$ 760,000
Cannot be determined.

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work
in process inventory at the end of the
month. What was the cost of goods
manufactured during the month?

A.
B.
C.
D.

McGrawHill/Irwin

$1,160,000
$ 910,000
$ 760,000
Cannot be determined.

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Beginning finished goods inventory was
$130,000. The cost of goods manufactured
for the month was $760,000. And the ending
finished goods inventory was $150,000.
What was the cost of goods sold for the
month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
McGrawHill/Irwin

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Quick Check
Beginning finished goods inventory was
$130,000. The cost of goods manufactured
for the month was $760,000. And the ending
finished goods inventory was $150,000.
What was the cost of goods sold for the
month?
A. $ 20,000. $130,000 + $760,000 = $890,000
B. $740,000. $890,000 - $150,000 = $740,000
C. $780,000.
D. $760,000.
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Cost Classifications for Predicting Cost

Behavior
How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
activity
activity within
within the
the
relevant
relevant range.
range.
Total
Totalvariable
variablecosts
costs
change
changewhen
whenactivity
activity
changes.
changes.
Total
Totalfixed
fixedcosts
costsremain
remain
unchanged
unchangedwhen
whenactivity
activity
changes.
changes.

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Total Variable Cost

Total Long Distance

Telephone Bill

Your total long distance telephone bill is based

on how many minutes you talk.

Minutes Talked
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Variable Cost Per Unit

Per Minute
Telephone Charge

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Minutes Talked
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Total Fixed Cost

Monthly Basic
Telephone Bill

Your monthly basic telephone bill probably

does not change when you make more local
calls.

Number of Local Calls

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Fixed Cost Per Unit

Monthly Basic Telephone

Bill per Local Call

The average fixed cost per local call decreases

as more local calls are made.

Number of Local Calls

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Cost Classifications for Predicting Cost

Behavior

Behavior of Cost (within the relevant range)

Cost

In Total

Per Unit

Variable

Total variable cost changes

as activity level changes.

Variable cost per unit remains

the same over wide ranges
of activity.

Fixed

Total fixed cost remains

the same even when the
activity level changes.

Average fixed cost per unit goes

down as activity level goes up.

McGrawHill/Irwin

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Quick Check
Which of the following costs would be variable with
respect to the number of cones sold at a Baskins &
Robbins shop? (There may be more than one
correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Which of the following costs would be variable with
respect to the number of cones sold at a Baskins &
Robbins shop? (There may be more than one
correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

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Assigning Costs to Cost Objects

Direct costs

Indirect costs

Costs that can be

easily and conveniently
traced to a unit of product
or other cost object.

Costs that cannot be easily

and conveniently traced to
a unit of product or other
cost object.

Examples: direct material

and direct labor

Example: manufacturing
overhead

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Cost Classifications for Decision

Making
Every decision involves a choice between at
least two alternatives.
Only those costs and benefits that differ
between alternatives are relevant in a decision.
All other costs and benefits can and should be
ignored.

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Differential Costs and Revenues

Costs and revenues that differ among

alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.

Differential revenue is:

$2,000 $1,500 = $500
Differential cost is:
$300
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Opportunity Costs
The potential benefit that is given
up when one alternative is
selected over another.

Example: If you were

not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for
one year is $15,000.
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Sunk Costs
Sunk costs have already been incurred and cannot be
changed now or in the future. They should be ignored when
making decisions.

Example: You bought an automobile that cost

$10,000 two years ago. The $10,000 cost is sunk
because whether you drive it, park it, trade it, or sell
it, you cannot change the $10,000 cost.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert. You
have ample cash to do either, but you dont want to
waste money needlessly. Is the cost of the train
ticket relevant in this decision? In other words,
should the cost of the train ticket affect the decision
of whether you drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert. You
have ample cash to do either, but you dont want to
waste money needlessly. Is the cost of the train
ticket relevant in this decision? In other words,
should the cost of the train ticket affect the decision
of whether you drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert. You
have ample cash to do either, but you dont want to
waste money needlessly. Is the annual cost of
licensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert. You
have ample cash to do either, but you dont want to
waste money needlessly. Is the annual cost of
licensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Summary of the Types of Cost

Classifications

Financial reporting
Predicting cost behavior
Assigning costs to cost objects
Decision making

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Copyright2006,TheMcGrawHillCompanies,Inc.

Idle Time
Machine
Breakdowns

Material
Shortages
Power
Failures

The labor costs incurred

during idle time are ordinarily
treated as manufacturing
overhead.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Overtime
The overtime premiums for all factory
workers are usually considered to be part
of manufacturing overhead.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Labor Fringe Benefits

Fringe benefits include employer paid
costs for insurance programs, retirement
plans, supplemental unemployment
programs, Social Security, Medicare,
workers compensation and
unemployment taxes.
Some companies
include all of these
costs in
manufacturing
overhead.
McGrawHill/Irwin

Other companies treat

fringe benefit
expenses of direct
laborers as additional
direct labor costs.
Copyright2006,TheMcGrawHillCompanies,Inc.

Quality of Conformance
When the overwhelming majority of
products produced conform to design
specifications and are free from
defects.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Prevention and Appraisal Costs

McGrawHill/Irwin

Prevention
Costs

Support activities
whose purpose is to
reduce the number of
defects

Appraisal Costs

Incurred to identify
defective products
before the products are
shipped

Copyright2006,TheMcGrawHillCompanies,Inc.

Internal and External Failure Costs

McGrawHill/Irwin

Internal Failure
Costs

Incurred as a result of
identifying defects
before they are shipped

External Failure
Costs

Incurred as a result of
defective products
being delivered to
customers

Copyright2006,TheMcGrawHillCompanies,Inc.

Examples of Quality Costs

Prevention Costs
Quality training
Quality circles
Statistical process
control activities

Internal Failure Costs

Scrap
Spoilage
Rework

McGrawHill/Irwin

Appraisal Costs
Testing & inspecting
incoming materials
Final product testing
Depreciation of testing
equipment

External Failure Costs

Cost of field servicing &
handling complaints
Warranty repairs
Lost sales

Copyright2006,TheMcGrawHillCompanies,Inc.

End of Chapter 2

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.