BE 601

Class 5 – Cost Classifications

Presented by: Michelle Lennox

Conrad School of Entrepreneurship and Business

Learning Objectives

• Basic types of manufacturing costs

• Direct vs indirect costs

• Product vs period costs

• To describe how manufacturing costs flow through inventory accounts

Cost Classifications PAGE 2

Learning Objective

To review the three

basic types of
manufacturing costs

Cost Classifications PAGE 3

Direct Material
Raw materials & component parts
that become an integral part of
finished products.

Can be traced directly and

conveniently to products.

If materials cannot be traced directly to products, the materials are

considered indirect and are part of manufacturing overhead.

Cost Classifications PAGE 4

Direct Labour
Includes the payroll cost of direct workers.

Those employees who work

directly on the goods being
manufactured.

The cost of employees in manufacturing who do not work directly on the

goods is considered indirect labor and is part of manufacturing overhead.

Cost Classifications PAGE 5

Manufacturing Overhead
All manufacturing costs other
than direct materials and direct
labor.

Examples includes:
• Indirect materials
• Indirect labor
• Machinery and equipment costs

Does not include selling or general and administrative expenses.

Cost Classifications PAGE 6

Flow of Physical Goods in Production
Direct Direct
Materials Materials
Purchased Used

Finished
Goods

Manufacturing Goods Sold

Direct Labor
Overhead

Cost Classifications PAGE 7

Learning Objective

To distinguish
between
direct and indirect
costs

Cost Classifications PAGE 8

Direct Costs and Indirect Costs
Direct costs Indirect costs
• Costs that can be  Costs cannot be easily and
easily and conveniently conveniently traced to a unit
traced to a unit of product of product or other cost
or other cost objective object
• Examples: direct material
 Example: manufacturing
and direct labor
overhead

Cost Classifications PAGE 9

Direct Costs
Direct Material

Direct Labour

If the cost object was not produced and as a

? result the cost is not consumed, and if the cost is

material relative to the total direct cost of the
product, then the cost is a direct cost.

Cost Classifications PAGE 10

Indirect Costs
• Factory manager salary

• Machinery depreciation

• Factory insurance

• Utilities bills

• etc

Any product cost that fails the direct cost test is

treated as an indirect cost

Cost Classifications PAGE 11

In class exercise
Classify each of the following costs as direct or indirect, assuming the cost object is a product.
You should make any assumption you feel are necessary to classify the cost.

Cost item Direct vs Indirect

Materials that become part of the product
Salaried labour
Supplies consumed in production
Depreciation on factory equipment
Cost of packaging materials for the finished
product
Shipping a trailer load of various products
Invoicing a customer
Cost of repairing a piece of production
equipment
Supervisory salary
Cost Classifications PAGE 12
In class exercise
Classify each of the following costs as direct or indirect, assuming the cost object is a product.
You should make any assumption you feel are necessary to classify the cost.
Cost item Direct vs Indirect
Materials that become part of the product Direct
Salaried labour Indirect
Supplies consumed in production Indirect
Depreciation on factory equipment Indirect (Direct if the equipment is used
for one specific cost object exclusively)
Cost of packaging materials for the finished product Direct
Shipping a trailer load of various products Indirect
Invoicing a customer Indirect
Cost of repairing a piece of production equipment Indirect
Supervisory salary Indirect

Cost Classifications PAGE 13

Learning Objective

To review and
distinguish between
product and period
costs

Cost Classifications PAGE 14

Product Costs and period Costs
Product costs Period costs
• All costs that are involved  Costs that are taken directly
in the purchase or to the income statement as
manufacture of goods. expenses in the period in
• In the case of which they were incurred.
manufactured goods,
 Examples include selling,
these costs consist of
marketing and
direct materials, direct
administrative costs
labour and manufacturing
overhead.

Cost Classifications PAGE 15

Product Costs and period Costs
Financial accountant Management accountant
Product cost includes only the cost of manufacturing or Start with the financial accountant’s definition, and can
acquiring a product add the cost of promoting, selling, distributing and
servicing the product in the customer’s hands if the
cost can be reasonably traced to the product

Cost Classifications PAGE 16

In class exercise
Label each of the following costs as product or period from the perspective of the financial accountant and the
management accountant (for purposes of this exercise, assume that the management accountant is doing a
total product cost analysis):
Cost item Financial accountant Management accountant
Factory supplies
Raw materials used in production
Head office design costs for a specific product
Factory supervisory costs
Cost to repair a product under warranty
Factory machine maintenance
Cost of shipping a product to a customer
Production worker overtime costs
Cost to repair product defects before shipping
Factory utility costs

Cost Classifications PAGE 17

In class exercise
Label each of the following costs as product or period from the perspective of the financial accountant and the
management accountant (for purposes of this exercise, assume that the management accountant is doing a
total product cost analysis):
Cost item Financial accountant Management accountant
Factory supplies Product Product
Raw materials used in production Product Product
Head office design costs for a specific product Period Product
Factory supervisory costs Product Product
Cost to repair a product under warranty Period Product
Factory machine maintenance Product Product
Cost of shipping a product to a customer Period Product
Production worker overtime costs Product Product
Cost to repair product defects before shipping Product Product
Factory utility costs Product Product

Cost Classifications PAGE 18

Paul’s Pools
The following is a partial list of costs incurred last month by Paul’s Pools

 Product Advertising $20,000

 Fire Insurance premium - factory 5,000

 Electricity - sales offices 2,000

 Lubricating materials for pool machine 4,000

What dollar amount of these costs would be
 Foam liners for pools 32,000 considered Product costs? Manufacturing
 Pool worker’s wages 46,000 O/H costs? Direct costs? Period costs?
 Rent, factory building 10,000

 Freight-out 6,000

 Salary - president 25,000

 Taxes - company headquarters 3,000

 Total $153,000

Cost Classifications PAGE 19

Paul’s Pools
The following is a partial list of costs incurred last month by Paul’s Pools

 Product Advertising $20,000

 Fire Insurance premium - factory 5,000

 Electricity - sales offices 2,000

 Lubricating materials for pool machine 4,000

 Foam liners for pools 32,000 What dollar amount of these costs would be
 Pool worker’s wages 46,000 considered Product costs?
 Rent, factory building 10,000
$97,000
 Freight-out 6,000

 Salary - president 25,000

 Taxes - company headquarters 3,000

 Total $153,000

Cost Classifications PAGE 20

Paul’s Pools
The following is a partial list of costs incurred last month by Paul’s Pools

 Product Advertising $20,000

 Fire Insurance premium - factory 5,000

 Electricity - sales offices 2,000

 Lubricating materials for pool machine 4,000

What dollar amount of these costs would be
 Foam liners for pools 32,000 considered Manufacturing O/H costs?
 Pool worker’s wages 46,000
$19,000
 Rent, factory building 10,000

 Freight-out 6,000

 Salary - president 25,000

 Taxes - company headquarters 3,000

 Total $153,000

Cost Classifications PAGE 21

Paul’s Pools
The following is a partial list of costs incurred last month by Paul’s Pools

 Product Advertising $20,000

 Fire Insurance premium - factory 5,000

 Electricity - sales offices 2,000

 Lubricating materials for pool machine 4,000

What dollar amount of these costs would be
 Foam liners for pools 32,000 considered Direct costs?
 Pool worker’s wages 46,000

 Rent, factory building 10,000 $78,000

 Freight-out 6,000

 Salary - president 25,000

 Taxes - company headquarters 3,000

 Total $153,000

Cost Classifications PAGE 22

Paul’s Pools
The following is a partial list of costs incurred last month by Paul’s Pools

 Product Advertising $20,000

 Fire Insurance premium - factory 5,000

 Electricity - sales offices 2,000

 Lubricating materials for pool machine 4,000

What dollar amount of these costs would be
 Foam liners for pools 32,000 considered Period costs?
 Pool worker’s wages 46,000
$56,000
 Rent, factory building 10,000

 Freight-out 6,000

 Salary - president 25,000

 Taxes - company headquarters 3,000

 Total $153,000

Cost Classifications PAGE 23

Learning Objective

To describe how
manufacturing costs
flow through
inventory
accounts

Cost Classifications PAGE 24

Inventories of a Manufacturing Business

Raw materials - inventory on

hand and available for use.

Work in process -
Finished goods- partially
completed goods completed goods.
awaiting sale.

Cost Classifications PAGE 25

Flow of Costs Associated With Production
Direct Materials Direct Work in Process
materials Inventory materials Inventory
purchased used
$$$ $$$ $$$ $$$

Direct labor &

Manufacturing Overhead

Cost of goods
manufactured
Finished Goods Cost of
Inventory Goods Sold
$$$ $$$ $$$
Cost Classifications PAGE 26
Flow of Costs Associated With Production
Pure-Ice Inc. had $52,000 of inventory in direct materials inventory on January
1, of this year. During the year, Pure-Ice purchased $586,000 of additional
direct materials. At December 31 of this year $78,000 of the direct materials
were still on hand.
How much direct material was placed into production during the year?

Cost Classifications PAGE 27

Flow of Costs Associated With Production

Beginning materials
inventory $
+ Materials purchased
Materials available to b
=
placed into product
Materials place
–
production
Ending
?
= inv

Cost Classifications PAGE 28

Flow of Costs Associated With Production

Beginning materials
inventory $ 52,000

!
+ Materials purchased 586,000
Materials available to be
=
placed into production 638,000
Materials placed into
?
production 560,000
Ending materials
=
inventory $ 78,000

Cost Classifications PAGE 29

Flow of Costs Associated With Production
In addition to the direct materials, Pure-Ice incurred $306,000 of direct
labor cost during the year. Manufacturing overhead for the year was
$724,000.
Pure-Ice started the year with $132,000 in work in process. During the year,
units costing $1,480,000 were transferred to finished goods inventory.
What is the balance in work in process at the end of the year?

Cost Classifications PAGE 30

Flow of Costs Associated With Production
B e g i n n i n g w o r k in
process inventory $ 132,000
+ M a n u f a ct urin g costs
added 1,590,000

Direct Materials $ 560,000

Direct Labor 306,000
Manufacturing
Overhead 724,000
Total costs added
during the year $ 1,590,000

Cost Classifications PAGE 31

Flow of Costs Associated With Production
B e g i n n i n g w o r k in
process inventory $ 1 3 2 , 0 00
+ Manufacturing costs

!
added 1,590,000
= To t a l c o s t s in p r o c e s s
d u r i n g t h e year 1,722,000
– Cost of g o o d s
completed during the
year 1,480,000
= E n d i n g w o r k in p r o c e s s
inventory $ 2 4 2 , 0 00

Cost Classifications PAGE 32

Learning Objective

To prepare a schedule
of the cost of finished
goods manufactured.

Cost Classifications PAGE 33

 CONQUEST, INC.
Schedule of the Cost of Finished Goods Manufactured
For the Year Ended December 31, 2007

Work in process inventory, beg. $ 30,000

Manufacturing cost assigned to
production:
Direct materials $ 150,000
Direct labor 300,000
Manufacturing overhead 360,000
Total manufacturing costs 810,000
Total cost of all work in process
during the year 840,000
Less: Work in process
inventory, end of year 40,000
Cost of finished goods manufactured $ 800,000

Cost Classifications PAGE 34

Cost of Goods Sold Beginning finished goods
inventory $ 150,000

Add: Cost of finished goods

manufactured during the year 800,000
Cost of finished goods
available for sale 950,000
CONQUEST, INC. Less: Ending finished goods
Schedule of the Cost of Finished Goods Manufactured
For the Year Ended December 31, 2007
inventory 168,000
Cost of goods sold $ 782,000
Work in process inventory, beg. $ 30,000
Manufacturing cost assigned to
production:
Direct Materials $ 150,000
Direct Labor 300,000
Manufacturing overhead 360,000
Total manufacturing costs 810,000 The cost of goods completed during
the period is used to compute COGS
Total cost of all work in process
during the year 840,000
Less: Work in process
inventory, end of year 40,000
for the period.
Cost of finished goods manufactured $ 800,000

Cost Classifications PAGE 35

 CONQUEST, INC.
Income Statement
The income For the Year Ended December 31, 2007
statement
is prepared Sales $ 1,300,000
using Cost of goods sold 782,000
established Gross profit on sales $ 518,000
Operating expenses 400,000
financial
Income from operations $ 118,000
accounting Less: Interest expense 18,000
procedures. Income before income
taxes $ 100,000
Income tax expense 30,000
Net income $ 70,000

Cost Classifications PAGE 36

 CONQUEST, INC.
Partial Balance Sheet
December 31, 2007

Current Assets:
Cash and Cash Equivalents
Accounts Receivable, net
Inventories
Materials
Work in P
Finish
T
To

Manufacturers have three inventory accounts.

Cost Classifications PAGE 37