Cost Terms, Concepts, and Classifications

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Chapter 2

Cost Terms, Concepts, and Classifications

Learning Objectives

LO1. Identify and give examples of each of the three basic manufacturing cost categories. LO2. Distinguish between product costs and period costs and give examples of each. LO3. Prepare an income statement including calculation of the cost of goods sold. LO4. Prepare a schedule of cost of goods manufactured. LO5. Understand the differences between variable costs and fixed costs. LO6. Understand the differences between direct and indirect costs. LO7. Define and give examples of cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs. LO8.
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2. Non-manufacturing costs. A manufacturing company incurs many other costs in addition to manufacturing costs. For financial reporting purposes most of these other costs are typically classified as selling (marketing) costs and administrative costs. Marketing and administrative costs are incurred in both manufacturing and merchandising firms.

a. Marketing Costs. These costs include the costs of making sales, taking customer orders, and delivering the product to customers. These costs are also referred to as order-getting and order-filling costs.

b. Administrative Costs. These costs include all executive, organizational, and clerical costs that are not classified as production or marketing costs.

3. Period vs. product costs. Costs can also be classified as period or product costs.

a. Period Costs. Period costs are expensed in the time period in which they are incurred. All selling and administrative costs are typically considered to be period costs. You should be careful to point out that the usual rules of accrual accounting apply. For example, administrative salary costs are “incurred” when they are earned and not necessarily when they are paid to employees.

b. Product Costs. Product costs are added to units of product (i.e., “inventoried”) as they are incurred and are not treated as expenses until the units are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and
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