COST ACCOUNTING AND CONTROL – Solutions Manual

CHAPTER 2
COST TERMS, CONCEPTS AND CLASSIFICATIONS

I. Answers to Questions

1. A cost object is anything for which a separate measurement of costs is desired.

Examples include a product, a service, a project, a customer, a brand category,
an activity, a department and a program.
2. Cost assignment is a general term that encompasses both (1) tracing
accumulated costs to a cost object and (2) allocating accumulated costs to a
cost object.
Cost tracing is the assignment of indirect costs to a chosen cost object.
Cost allocation is the assigning of indirect costs to a chosen cost object.
The relationship between these terms is as follows:
Direct costs Cost tracing
Cost Assignment Cost object
Indirect costs Cost allocation
3. Cost reduction efforts frequently focus on:
1. Doing only value-added activities, and
2. Efficiently managing the use of the cost drivers in those value-added
activities.
4. Descriptions of the three sectors are:
 Service-sector companies provide services or intangible products to their
customers—for example, legal advice or an audit. These companies do not
have any inventory of intangible products at the end of an accounting
period.
 Merchandising-sector companies provide tangible products they have
previously purchased in the same basic form from suppliers. Merchandise
purchased from suppliers but not sold at the end of an accounting period is
held as inventory.
 Manufacturing-sector companies provide tangible products that have been
converted to a different form from the products purchased from suppliers.
At the end of an accounting period, inventory of a manufacturer can
include direct materials, work in process and finished goods.
Thus, manufacturing and merchandising companies have inventory, while
service companies do not. Manufacturing companies have direct materials,
work in process and finished goods inventories, whereas merchandising
companies have only goods purchased for resale inventory (merchandise
inventory).

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5. Capitalized costs are costs that are first recorded as an asset (capitalized) when
they are incurred. These costs are presumed to provide future benefits to the
company. Examples are costs to acquire computer equipment and motor
vehicles. Noncapitalized costs are costs that are recorded as expenses of the
accounting period when they are incurred. Examples are salaries:
Capitalized Costs Noncapitalized Costs
Service Cost to purchase Cost of telephone calls.
computer equipment.
Merchandising Cost of shelving used to Salary of checkout
display merchandise. people.
Manufacturing Cost of materials used Cost of petrol consumed
in manufacturing by sales people.
process
6. A product cost is the sum of the costs assigned to a product for a specific
purpose.
Purposes for computing a product cost include:
 Product pricing and product emphasis.
 Contracting with government agencies.
 Financial statements presentation.
7. The phrase “different costs for different purposes” refers to the fact that the
word “cost” can have different meanings depending on the context in which it
is used. Cost data that are classified and recorded in a particular way for one
purpose may be inappropriate for another use.
8. Fixed costs remain constant in total across changes in activity, whereas
variable costs change in proportion to the level of activity.
9. Examples of direct costs of the food and beverage department in a hotel
include the money spent on the food and beverages served, the wages of table
service personnel, and the costs of entertainment in the dining room and
lounge. Examples of indirect costs of the food and beverage department
include allocations of the costs of advertising for the entire hotel, of the costs
of the grounds and maintenance department, and of the hotel general
manager’s salary.
10. The cost of idle time is treated as manufacturing overhead because it is a
normal cost of the manufacturing operation that should be spread out among
all of the manufactured products. The alternative to this treatment would be to
charge the cost of idle time to a particular job that happens to be in process
when the idle time occurs. Idle time often results from a random event, such
as a power outage. Charging the cost of the idle time resulting from such a
random event to only the job that happened to be in process at the time would
overstate the cost of that job.

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11. a. Uncontrollable cost
b. Controllable cost
c. Uncontrollable cost
12. Product costs are costs that are associated with manufactured goods until the
time period during which the products are sold, when the product costs become
expenses. Period costs are expensed during the time period in which they are
incurred.
13. The most important difference between a manufacturing firm and a service
industry firm, with regard to the classification of costs, is that the goods
produced by a manufacturing firm are inventoried, whereas the services
produced by a service industry firm are consumed as they are produced. Thus,
the costs incurred in manufacturing products are treated as product costs until
the period during which the goods are sold. Most of the costs incurred in a
service industry firm to produce services are operating expenses that are
treated as period costs.
14. Product costs are also called inventoriable costs because they are assigned to
manufactured goods that are inventoried until a later period, when the products
are sold. The product costs remain in the finished goods inventory account
until the time period when the goods are sold.
15. A sunk cost is a cost that was incurred in the past and cannot be altered by any
current or future decision. A differential cost is the difference in a cost item
under two decision alternatives.
16. a. Direct cost c. Indirect cost
b. Direct cost d. Indirect cost
17. The two properties of a relevant cost are:
1. it differs between the decision options
2. it will be incurred in the future
18. The three types of product costs are:
1. direct materials – the materials used in manufacturing the product, which
become a physical part of the finished product.
2. direct labor – the labor used in manufacturing the product.
3. factory overhead – the indirect costs for materials, labor, and facilities
used to support the manufacturing process, but not used directly in
manufacturing the product.
19. The three types of manufacturing inventories are:
1. materials inventory – the store of materials used in the manufacturing
process or in providing the service.

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 2.
work in process inventory – accounts for all costs put into the
manufacturing of products that are started but not complete at the financial
statement date.
3. finished goods inventory – the cost of goods that are ready for sale.
20. The income statement of a manufacturing company differs from the income
statement of a merchandising company in the cost of goods sold section. A
merchandising company sells finished goods that it has purchased from a
supplier. These goods are listed as “purchases” in the cost of goods sold
section. Since a manufacturing company produces its goods rather than buying
them from a supplier, it lists “cost of goods manufactured” in place of
“purchases.” Also, the manufacturing company identifies its inventory in this
section as Finished Goods inventory, rather than as Merchandise Inventory.
21. Manufacturing overhead is an indirect cost since these costs cannot be easily
and conveniently traced to particular units of products
22.
Direct labor cost (34 hours  P15 per hour).................................... P510
Manufacturing overhead cost (6 hours  P15 per hour)................. 90
23.
Total wages earned.......................................................................... P600
Direct labor cost (45 hours  P14 per hour).................................. P630
Manufacturing overhead cost (5 hours  P7 per hour)................. 35
Total wages earned.................................... P665

II. Answers to Exercises

Exercise 1 (Schedule of Cost of Goods Manufactured and Sold; Income

Statement)

Requirement 1
Amazing Aluminum Company
Schedule of Cost of Goods Manufactured
For the Year Ended December 31, 20X1

Direct material:
Raw-material inventory, January 1......................... P 60,000
Add: Purchases of raw material.............................. 250,000
Raw material available for use................................ P310,000
Deduct: Raw-material inventory, December 31 70,000

Raw material used P240,000

Direct labor..................................................................... 400,000

Manufacturing overhead:
Indirect material P 10,000

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 Indirect labor 25,000

Depreciation on plant and equipment 100,000

Utilities 25,000
...........................................................................
...........................................................................
Other 30,000
...........................................................................
...........................................................................
Total manufacturing overhead 190,000

Total manufacturing costs.............................................. P830,000

Add: Work-in-process inventory, January 1................. 120,000
Subtotal........................................................................... P950,000
..................................................................................
Deduct: Work-in-process inventory, December 1........ 115,000
Cost of goods manufactured........................................... P835,000

Requirement 2
Amazing Aluminum Company
Schedule of Cost of Goods Sold
For the Year Ended December 31, 20X1

Finished goods inventory, January 1.................................................. P150,000

Add: Cost of goods manufactured..................................................... 835,000
Cost of goods available for sale......................................................... P985,000
Deduct: Finished goods inventory, December 31............................. 165,000
Cost of goods sold............................................................................... P820,000

Requirement 3
Amazing Aluminum Company
Income Statement
For the Year Ended December 31, 20X1

Sales revenue...................................................................................... P1,105,000

Less: Cost of goods sold.................................................................... 820,000
Gross margin....................................................................................... P 285,000
Selling and administrative expenses.................................................. 110,000
Income before taxes............................................................................ P 175,000
Income tax expense............................................................................. 70,000
Net income ........................................................................................ P 105,000

Exercise 2

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 Fixed (F) Period (P)
Cost Item Variable (V) Product (R)
a. Transportation-in costs on materials
purchased V R
b. Assembly-line workers’ wages V R
c. Property taxes on work in process V R
inventories
d. Salaries of top executives in the company F P
e. Overtime premium for assembly workers V R
f. Sales commissions V P
g. Sales personnel office rental F P
h. Production supervisory salaries F R
i. Controller’s office supplies F P
Fixed (F) Period (P)
Cost Item Variable (V) Product (R)
j. Executive office heat and air conditioning F P
k. Executive office security personnel F P
l. Supplies used in assembly work V R
m. Factory heat and air conditioning F R
n. Power to operate factory equipment V R
o. Depreciation on furniture for sales staff F P
p. Varnish used for finishing product V R
q. Marketing personnel health insurance F P
r. Packaging materials for finished product V R
s. Salary of the quality control manager who
checks work on the assembly line F R
t. Assembly-line workers’ dental insurance F R

Exercise 3 (Cost Classifications; Manufacturer)

1. a, d, g, i
2. a, d, g, j
3. b, f
4. b, d, g, k
5. a, d, g, k
6. a, d, g, j
7. b, c, f
8. b, d, g, k
9. b, c and d*, e and f and g*, k*
* The building is used for several purposes.
10. b, c, f

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11. b, c, h
12. b, c, f
13. b, c, e
14. b, c and d†, e and f and g†, k†
†
The building that the furnace heats is used for several purposes.
15. b, d, g, k

Exercise 4 (Economic Characteristics of Costs)

1. marginal cost 4. opportunity cost

2. sunk cost 5. differential cost
3. average cost 6. out-of-pocket cost
Exercise 5 (Cost Classifications; Hotel)

1. a, c, e, k
2. b, d, e, k
3. d, e, i
4. d, e, i
5. a, d, e, k
6. a, d, e, k
7. d, e, k
8. b, d†, e, k
†
Unless the dishwasher has been used improperly.
9. h
10. a, d, e*, j
* The hotel general manager may have some control over the total space
allocated to the kitchen.
11. i
12. j
13. a, c, e
14. e, k

Exercise 6

Pickup Truck Output

3,000 trucks 6,000 trucks 9,000 trucks

Variable production costs P 29,640,000 P 59,280,000 P 88,920,000
Fixed production costs 39,200,000 39,200,000 39,200,000

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Variable selling costs 4,500,000 9,000,000 13,500,000
Fixed selling costs 13,660,000 13,660,000 13,660,000
Total costs P 87,000,000 P121,140,000 P155,280,000

Selling price per truck 46,000 40,100 35,900

Unit cost 29,000 20,190 17,253

Profit per truck 17,000 19,910 18,647

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 Exercise 7

Period Product Cost

Variable Fixed Cost (Selling and Direct Direct Manufacturing Sunk Cost Opportunity
Cost Administrative) Cost Materials Labor Overhead Cost
1. Wood used in a table (P200
X X
per table)
2. Labor cost to assemble a
X X
table (P80 per table)
3. Salary of the factory
supervisor (P76,000 per X X
year)
4. Cost of electricity to
produce tables (P4 per X X
machine-hour)
5. Depreciation of machines
used to produce tables X X X*
(P20,000 per year)
6. Salary of the company
president (P200,000 per X X
year)
7. Advertising expense
X X
(P500,000 per year)
8. Commissions paid to
salespersons (P60 per table X X
sold)
9. Rental income forgone on
X1
factory space
*
This is a sunk cost because the outlay for the equipment was made in a previous period.
1
This is an opportunity cost because it represents the potential benefit that is lost or sacrificed as a result of using the factory space to produce tables. Opportunity
cost is a special category of cost that is not ordinarily recorded in an organization’s accounting books. To avoid possible confusion with other costs, we will not
attempt to classify this cost in any other way except as an opportunity cost.

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 Exercise 8

1. The wages of employees who build the sailboats: direct labor cost.
2. The cost of advertising in the local newspapers: marketing and selling cost.
3. The cost of an aluminum mast installed in a sailboat: direct materials cost.
4. The wages of the assembly shop’s supervisor: manufacturing overhead cost.
5. Rent on the boathouse: a combination of manufacturing overhead,
administrative, and marketing and selling cost. The rent would most likely be
prorated on the basis of the amount of space occupied by manufacturing,
administrative, and marketing operations.
6. The wages of the company’s bookkeeper: administrative cost.
7. Sales commissions paid to the company’s salespeople: marketing and selling
cost.
8. Depreciation on power tools: manufacturing overhead cost.

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Exercise 9

Direc Indirec
t t
Cost Cost Object Cost Cost
1. The salary of the head chef The hotel’s restaurant X
2. The salary of the head chef A particular restaurant X
customer
3. Room cleaning supplies A particular hotel guest X
4. Flowers for the reception A particular hotel guest X
desk
5. The wages of the doorman A particular hotel guest X
6. Room cleaning supplies The housecleaning X
department
7. Fire insurance on the hotel The hotel’s gym X
building
8. Towels used in the gym The hotel’s gym X

Note: The room cleaning supplies would most likely be considered an indirect cost
of a particular hotel guest because it would not be practical to keep track of exactly
how much of each cleaning supply was used in the guest’s room.

III. Answers to Multiple Choice Questions

1. B 7. C 13. D 19. A 25. C

2. D 8. D 14. D† 20. A* 26. B
3. B 9. C 15. B† 21. B 27. B
4. A 10. C 16. A† 22. B 28. A **
5. C 11. A 17. C† 23. C 29. A
6. D 12. C 18. C 24. C 30. B

* Controllable costs are those costs that can be influenced by a specified

manager within a given time period.
** The answer assumes absorption costing method is used.
†
Supporting Computations
14. P60 + P10 + P18 + P4 = P92 16. P60 + P10 + P18 + P32 = P120
15. P32 + P16 = P48 17. P4 + P16 = P20

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IV. Answers to Problems

Problem 1

The relevant costs for this decision are the differential costs. These are:

Opportunity cost or lost wages (take home)

[P1,500 x 70% x 12 months]............. P12,600
Tuition............................................................ 2,200
Books and supplies........................................ 300
Total differential costs........................... P15,100

Room and board, clothing, car, and incidentals are not relevant because these are
presumed to be the same whether or not Francis goes to school. The possibility of
part-time work, summer jobs, or scholarship assistance could be considered as
reductions to the cost of school. If students are familiar with the time value of
money, then they should recognize that the analysis calls for a comparison of the
present value of the differential after-tax cash inflows with the present value of
differential costs of getting the education (including the opportunity costs of lost
income).

Problem 2

Requirement (a)

Only the differential outlay costs need be considered. The travel and other variable
expenses of P22 per hour would be the relevant costs. Any amount received in
excess would be a differential, positive return to Pat.

Requirement (b)

The opportunity cost of the hours given up would be considered in this situation.
Unless Pat receives more than the P100 normal consulting rate, the contract would
not be beneficial.

Requirement (c)

In this situation Pat would have to consider the present value of the contract and
compare that to the present value of the existing consulting business. The final rate
may be more or less than the normal P100 rate depending on the outcome of Pat’s
analysis.

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Problem 3

Utilities for the bakery 2,100

Paper used in packaging product 90
Salaries and wages in the bakery 19,500
Cookie ingredients 35,000
Bakery labor and fringe benefits 1,300
Bakery equipment maintenance 800
Depreciation of bakery plant and equipment 2,000
Uniforms 400
Insurance for the bakery 900
Boxes, bags, and cups used in the bakery 1,100
Bakery overtime premiums 2,600
Bakery idle time 500
Total product costs in pesos 66,290

Problem 4

Administrative costs 1,000

Rent for administration offices 17,200
Advertising 1,900
Office manager’s salary 13,000
Total period costs in pesos 33,100

Problem 5

Requirement (a)

Sunk costs not shown could include lost book value on traded assets, depreciation
estimates for new investment, and interest costs on capital needed during facilities
construction.

Requirement (b)

The client might be used to differential cost as a decision tool, and believes
(correctly) that use of differential analyses has several advantages --- it is quicker,
requires less data, and tends to give a better focus to the decision. The banker
might suspect the client of hiding some material data in order to make the proposal
more acceptable to the financing agency.

Problem 6

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 Requirement (1)

EH Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31

Direct materials:
Raw materials, inventory, January 1 P 45,000
Add: Purchases of raw materials 375,000
Raw materials available for use 420,000
Deduct: Raw materials inventory,
December 31 30,000
Raw materials used in production P 390,000
Direct labor 75,000
Manufacturing overhead:
Utilities, factory 18,000
Depreciation, factory 81,000
Insurance, factory 20,000
Supplies, factory 7,500
Indirect labor 150,000
Maintenance, factory 43,500
Total manufacturing overhead cost 320,000
Total manufacturing cost 785,000
Add: Work in process inventory, January 1 90,000
875,000
Deduct: Work in process inventory,
December 31 50,000
Cost of goods manufactured P825,000

Requirement (2)

The cost of goods sold would be computed as follows:

Finished goods inventory, January 1 P130,000

Add: Cost of goods manufactured 825,000
Goods available for sale 955,000
Deduct: Finished goods inventory, December 31 105,000
Cost of goods sold P850,000

Requirement (3)

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 EH Corporation
Income Statement
For the Year Ended December 31

Sales P1,250,000
Cost of goods sold (above) 850,000
Gross margin 400,000
Selling and administrative expenses:
Selling expenses P 70,000
Administrative expenses 135,000 205,000
Net operating income P 195,000

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Problem 7

Note to the Instructor: Some of the answers below are debatable.

Manufacturing
Variable or Selling Adminis- (Product) Cost
Cost Item Fixed Cost trative Cost Direct Indirect
1. Depreciation, executive jet........................................................................................ F X
2. Costs of shipping finished goods to customers......................................................... V X
3. Wood used in manufacturing furniture..................................................................... V X
4. Sales manager’s salary.............................................................................................. F X
5. Electricity used in manufacturing furniture.............................................................. V X
6. Secretary to the company president.......................................................................... F X
7. Aerosol attachment placed on a spray can produced by the company.................... V X
8. Billing costs............................................................................................................... V X*
9. Packing supplies for shipping products overseas...................................................... V X
10. Sand used in manufacturing concrete....................................................................... V X
11. Supervisor’s salary, factory....................................................................................... F X
12. Executive life insurance............................................................................................ F X
13. Sales commissions..................................................................................................... V X
14. Fringe benefits, assembly line workers..................................................................... V   X**
15. Advertising costs....................................................................................................... F X
16. Property taxes on finished goods warehouses........................................................... F X
17. Lubricants for production equipment........................................................................ V X
 *Could be an administrative cost.
**Could be an indirect cost.

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 Answer to Test Material 2-1

Problem A

Requirement (1)

Period
(Selling
Product Cost and
Variable Fixed Direct Direct Mfg. Admin.) Opportunity Sunk
Name of the Cost Cost Cost Materials Labor Overhead Cost Cost Cost
Ling’s present salary of P400,000 per
month.......................................................................... X
Rent on the garage, P15,000 per month........................... X X
Rent of production equipment, P50,000 per
month.......................................................................... X X
Materials for producing flyswatters, at
P30.00 each.................................................................
X X
Labor cost of producing flyswatters, at
P50.00 each.................................................................
X X
Rent of room for a sales office, P7,500 per
month.......................................................................... X X
Answering device attachment, P2,000 per
month.......................................................................... X X
Interest lost on savings account, P100,000
per year........................................................................ X
Advertising cost, P40,000 per month.............................. X X
Sales commission, at P10.00 per flyswatter.................... X X
Legal and filing fees, P60,000......................................... X

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Requirement (2)

The P60,000 legal and filing fees are not a differential cost. These legal and filing
fees have already been paid and are a sunk cost. Thus, the cost will not differ
depending on whether Ling decides to produce flyswatters or to stay with the
consulting firm. All other costs listed above are differential costs since they will be
incurred only if Ling leaves the consulting firm and produces the flyswatters.

Problem B

Requirement (1)

Ms. Rio’s first action was to direct that discretionary expenditures be delayed until
the first of the new year. Providing that these “discretionary expenditures” can be
delayed without hampering operations, this is a good business decision. By
delaying expenditures, the company can keep its cash a bit longer and thereby earn
a bit more interest. There is nothing unethical about such an action. The second
action was to ask that the order for the parts be cancelled. Since the clerk’s order
was a mistake, there is nothing unethical about this action either.

The third action was to ask the accounting department to delay recognition of the
delivery until the bill is paid in January. This action is dubious. Asking the
accounting department to ignore transactions strikes at the heart of the integrity of
the accounting system. If the accounting system cannot be trusted, it is very
difficult to run a business or obtain funds from outsiders. However, in Ms. Rio’s
defense, the purchase of the raw materials really shouldn’t be recorded as an
expense. He has been placed in an extremely awkward position because the
company’s accounting policy is flawed.

Requirement (2)

The company’s accounting policy with respect to raw materials is incorrect. Raw
materials should be recorded as an asset when delivered rather than as an expense.
If the correct accounting policy were followed, there would be no reason for Ms.
Rio to ask the accounting department to delay recognition of the delivery of the
raw materials. This flawed accounting policy creates incentives for managers to
delay deliveries of raw materials until after the end of the fiscal year. This could
lead to raw materials shortages and poor relations with suppliers who would like to
record their sales before the end of the year.

The company’s “manage-by-the-numbers” approach does not foster ethical

behavior—particularly when managers are told to “do anything so long as you hit
the target profits for the year.” Such “no excuses” pressure from the top too often
leads to unethical behavior when managers have difficulty meeting target profits.

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