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CHAPTER 3
Product Costing: Manufacturing Processes, Cost Terminology, and Cost Flows
© 2009 Cengage Learning
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Manufacturing, Merchandising and Service Organizations
Manufacturing: Take raw materials and produce new products from them.
Merchandising: Retail and wholesale merchandising companies sell products that someone else has manufactured.
Service: Provide a service such as airlines, hospitals, repair shops, law firms, CPA firms.
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The Production Process
Manufacturing companies purchase raw materials from other companies and transform them into a finished product by adding labor and other costs, such as utilities, depreciation or supplies.
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The Production Process
Inventories in a Traditional Environment
•Raw Materials
•Work-in-Process (WIP)
•Finished Goods
Inventories serve as buffers in case of unexpected demand for products or unexpected problems in production.
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The Production Process
Lean production and manufacturing in a JIT environment
•Lean production•Is focused on eliminating waste and managing inventory•Materials are purchased and products are made
“just in time” to meet customer demand•Process begins with customer order and products are “pulled” through the process
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The Production Process
Lean production and JIT are more than inventory
management tools.
Key Concept
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Product Costs in a Manufacturing Company
Manufacturing CostsCosts incurred in the
factory or plant
Nonmanufacturing CostsCosts that are incurred outside
the plant or factory and typically categorized as selling
and administrative costs.
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Manufacturing or Nonmanufacturing?
The key is to think about where in the process the cost occurs.
If the cost occurs in the factory while the product is being produced, it is a
manufacturing cost.
If the cost occurs after the product is produced or outside the
manufacturing area, then it is a nonmanufacturing cost.
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Direct Materials and Direct Labor
Direct Materials Can be directly and conveniently traced to a particular product and become an integral
part of the finished product
Direct Labor The labor cost of all production employees
who work directly on the product being made or service being provided
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Manufacturing Overhead
•Indirect Material •Screws and solder
•Indirect Labor•Janitors, maintenance workers, supervisors
•Depreciation•Factory equipment and building
•Repairs and Maintenance•Rent•Insurance•Utilities
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Life-Cycle Costs and the Value Chain
Research & Development
Experiment materials
Staff
Product Development
Design specs
Staff
Production
Direct materials
Direct labor
Manufacturing overhead
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Life-Cycle Costs and the Value Chain (continued)
Marketing
Advertising and
promotions
Staff
Distribution
Shipping costs
Trucks
Drivers
Customer Service
Call center personnel
Phone and computer equipment
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Cost Flows in a Manufacturing Company
Direct Materials
+ Direct Labor
+ Manufacturing Overhead
The Cost to Produce the Product
Costs flow in the same way that products flow through a production facility.
Key Concept
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Cost Flows in a Manufacturing Company
When the product is sold, the product costs become:
Cost of Goods Sold
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Cost Flows in a Manufacturing Company
Raw Materials
Beginning Inventory
+ Purchases
= Cost of Raw Materials Available for Use
- Ending Inventory
= Raw Materials UsedTo Work in
Process
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Cost Flows in a Manufacturing Company
Work in Process Beginning Inventory
+ Raw Materials Used
+ Direct Labor
+ Manufacturing Overhead
- Ending Inventory
= Cost of Goods Manufactured
To Finished Goods
From Raw Material
Inventory
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Cost Flows in a Manufacturing Company
Finished Goods
Beginning Inventory
+ Cost of Goods Manufactured
= Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
From WIP
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Cost Flows in a Manufacturing CompanyRaw Materials
In Out
Work in Process
In Out
Beginning Inventory
Purchases
Raw Materials
Used
Ending Inventory
Beginning Inventory
Raw Materials Used
Direct Labor
Manufacturing Overhead
Ending Inventory
Cost of Goods Manufactured
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Cost Flows in a Manufacturing Company Work in Process
In Out
Cost of Goods Manufactured
Finished Goods
In Out
Cost of Goods Sold
In OutBeginning Inventory
CGM
Ending Inventory
Cost of Goods Sold
Cost of Goods Sold
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Cost Flows in a Manufacturing Company, JIT Environment
Direct materials, direct labor and overhead costs can essentially
be accumulated directly in a cost of goods sold account
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Merchandising Companies and the Cost of Products
Beginning Inventory
+ Cost of Goods Purchased
= Cost of Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
Cost of Goods Sold
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Service Companies and the Cost of Services
Service Firms
Small amount of direct material
Large amounts of direct labor
Large amounts of overhead
Use Work In Process accounts to accumulate and track costs for projects not yet complete
at the end of a period
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Product Costs and Period Costs
Product CostsInventoriable costs
Direct materials, direct labor, overhead costs
Stay with product until the product is sold
Included in one of three inventory accounts
Period CostsNonmanufacturing costs
Expensed in the period incurred
Included in selling and administrative costs
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The Path to the Income Statement
Direct Materials
Direct Labor
Factory Overhead
Balance Sheet
InventoriesIncome
Statement
Period Costs
As products are produced
As products are sold
Every period
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Product Costs and Period Costs
Product costs attach to the product and are expensed only when the product is sold, whereas period
costs are expensed in the period in which they are incurred.
Key Concept
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