CHAPTER 2

AN INTRODUCTION TO COST TERMS AND PURPOSES

2-33 (30–40 min.) Cost of goods manufactured, income statement, manufacturing

company.

Piedmont Corporation
Schedule of Cost of Goods Manufactured
Year Ended December 31, 2011
(in thousands)

Direct materials costs

Beginning inventory, January 1, 2011 $ 65,000
Purchases of direct materials 128,000
Cost of direct materials available for use 193,000
Ending inventory, December 31, 2011 34,000
Direct materials used $159,000
Direct manufacturing labor costs 106,000
Indirect manufacturing costs
Indirect manufacturing labor 48,000
Indirect materials 14,000
Plant insurance 2,000
Depreciation—plant building & equipment 21,000
Plant utilities 12,000
Repairs and maintenance—plant 8,000
Equipment lease costs 32,000
Total indirect manufacturing costs 137,000
Manufacturing costs incurred during 2011 402,000
Add beginning work-in-process inventory, January 1, 2011 83,000
Total manufacturing costs to account for 485,000
Deduct ending work-in-process inventory, December 31, 2011 72,000
Cost of goods manufactured (to Income Statement) $413,000

Piedmont Corporation
Income Statement
Year Ended December 31, 2011
(in thousands)

Revenues $600,000
Cost of goods sold:
Beginning finished goods, January 1, 2011 $123,000
Cost of goods manufactured 413,000
Cost of goods available for sale 536,000
Ending finished goods, December 31, 2011 102,000
Cost of goods sold 434,000
Gross margin 166,000
Operating costs:
Marketing, distribution, and customer-service costs 62,000
General and administrative costs 34,000
Total operating costs 96,000
Operating income $ 70,000

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2-34 (25–30 min.) Income statement and schedule of cost of goods manufactured.

Howell Corporation
Income Statement for the Year Ended December 31, 2011
(in millions)

Revenues $950
Cost of goods sold
Beginning finished goods, Jan. 1, 2011 $ 70
Cost of goods manufactured (below) 645
Cost of goods available for sale 715
Ending finished goods, Dec. 31, 2011 55 660
Gross margin 290
Marketing, distribution, and customer-service costs 240
Operating income $ 50

Howell Corporation
Schedule of Cost of Goods Manufactured
for the Year Ended December 31, 2011
(in millions)

Direct materials costs

Beginning inventory, Jan. 1, 2011 $ 15
Purchases of direct materials 325
Cost of direct materials available for use 340
Ending inventory, Dec. 31, 2011 20
Direct materials used $320
Direct manufacturing labor costs 100
Indirect manufacturing costs
Indirect manufacturing labor 60
Plant supplies used 10
Plant utilities 30
Depreciation––plant and equipment 80
Plant supervisory salaries 5
Miscellaneous plant overhead 35 220
Manufacturing costs incurred during 2011 640
Add beginning work-in-process inventory, Jan. 1, 2011 10
Total manufacturing costs to account for 650
Deduct ending work-in-process, Dec. 31, 2011 5
Cost of goods manufactured $645

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2-35 (15–20 min.) Interpretation of statements (continuation of 2-32).

1. The schedule in 2-34 can become a Schedule of Cost of Goods Manufactured and Sold
simply by including the beginning and ending finished goods inventory figures in the supporting
schedule, rather than directly in the body of the income statement. Note that the term cost of
goods manufactured refers to the cost of goods brought to completion (finished) during the
accounting period, whether they were started before or during the current accounting period.
Some of the manufacturing costs incurred are held back as costs of the ending work in process;
similarly, the costs of the beginning work in process inventory become a part of the cost of goods
manufactured for 2011.

2. The sales manager’s salary would be charged as a marketing cost as incurred by both
manufacturing and merchandising companies. It is basically an operating cost that appears below
the gross margin line on an income statement. In contrast, an assembler’s wages would be
assigned to the products worked on. Thus, the wages cost would be charged to Work-in-Process
and would not be expensed until the product is transferred through Finished Goods Inventory to
Cost of Goods Sold as the product is sold.

3. The direct-indirect distinction can be resolved only with respect to a particular cost
object. For example, in defense contracting, the cost object may be defined as a contract. Then, a
plant supervisor working only on that contract will have his or her salary charged directly and
wholly to that single contract.

4. Direct materials used = $320,000,000 ÷ 1,000,000 units = $320 per unit

Depreciation on plant equipment = $80,000,000 ÷ 1,000,000 units = $80 per unit

5. Direct materials unit cost would be unchanged at $320 per unit. Depreciation cost per
unit would be $80,000,000 ÷ 1,200,000 = $66.67 per unit. Total direct materials costs would rise
by 20% to $384,000,000 ($320 per unit × 1,200,000 units), whereas total depreciation would be
unaffected at $80,000,000.

6. Unit costs are averages, and they must be interpreted with caution. The $320 direct materials
unit cost is valid for predicting total costs because direct materials is a variable cost; total direct
materials costs indeed change as output levels change. However, fixed costs like depreciation
must be interpreted quite differently from variable costs. A common error in cost analysis is to
regard all unit costs as one —as if all the total costs to which they are related are variable costs.
Changes in output levels (the denominator) will affect total variable costs, but not total fixed
costs. Graphs of the two costs may clarify this point; it is safer to think in terms of total costs
rather than in terms of unit costs.

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2-36 (25–30 min.) Income statement and schedule of cost of goods manufactured.

Calendar Corporation
Income Statement
for the Year Ended December 31, 2011
(in millions)

Revenues $355
Cost of goods sold
Beginning finished goods, Jan. 1, 2011 $ 47
Cost of goods manufactured (below) 228
Cost of goods available for sale 275
Ending finished goods, Dec. 31, 2011 11 264
Gross margin 91
Marketing, distribution, and customer-service costs 94
Operating income (loss) $ (3)

Calendar Corporation
Schedule of Cost of Goods Manufactured
for the Year Ended December 31, 2011
(in millions)

Direct material costs

Beginning inventory, Jan. 1, 2011 $ 32
Direct materials purchased 84
Cost of direct materials available for use 116
Ending inventory, Dec. 31, 2011 8
Direct materials used $108
Direct manufacturing labor costs 42
Indirect manufacturing costs
Plant supplies used 4
Property taxes on plant 2
Plant utilities 9
Indirect manufacturing labor costs 27
Depreciation––plant and equipment 6
Miscellaneous manufacturing overhead costs 15 63
Manufacturing costs incurred during 2011 213
Add beginning work-in-process inventory, Jan. 1, 2011 18
Total manufacturing costs to account for 231
Deduct ending work-in-process inventory, Dec. 31, 2011 3
Cost of goods manufactured (to income statement) $228

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2-37 (15–20 min.)Terminology, interpretation of statements (continuation of 2-34).

1. Direct materials used $108 million

Direct manufacturing labor costs 42 million
Prime costs $150 million

Direct manufacturing labor costs $ 42 million

Indirect manufacturing costs 63 million
Conversion costs $105 million

2. Inventoriable costs (in millions) for Year 2011

Plant utilities $ 9
Indirect manufacturing labor 27
Depreciation—plant and equipment 6
Miscellaneous manufacturing overhead 15
Direct materials used 108
Direct manufacturing labor 42
Plant supplies used 4
Property tax on plant 2
Total inventoriable costs $213
Period costs (in millions) for Year 2011
Marketing, distribution, and customer-service costs $ 94

3. Design costs and R&D costs may be regarded as product costs in case of contracting with
a governmental agency. For example, if the Air Force negotiated to contract with Lockheed to
build a new type of supersonic fighter plane, design costs and R&D costs may be included in the
contract as product costs.

4. Direct materials used = $108,000,000 ÷ 2,000,000 units = $54 per unit

Depreciation on plant and equipment = $6,000,000 ÷ 2,000,000 units = $3 per unit

5. Direct materials unit cost would be unchanged at $108. Depreciation unit cost would be
$6,000,000 ÷ 3,000,000 = $2 per unit. Total direct materials costs would rise by 50% to
$162,000,000 ($54 per unit × 3,000,000 units). Total depreciation cost of $6,000,000 would
remain unchanged.

6. In this case, equipment depreciation is a variable cost in relation to the unit output. The
amount of equipment depreciation will change in direct proportion to the number of units
produced.
(a) Depreciation will be $2 million (2 million × $1) when 2 million units are produced.
(b) Depreciation will be $3 million (3 million × $1) when 3 million units are produced.

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