What do we mean by Costs? Period vs Product
What is Expense?
Costs on Financial Statements Income Statement
Balance Sheet
Statement of Cash flows
Manufacturing Cost Flows
Outcomes
Compute the flow of costs through manufacturing cycles and the determination of product (or service) cost.
Discuss the impact of flow of costs and product cost on decision making.
Describe the issues and procedures for the allocation of overhead costs, including activity-based costing.
Use commonly used tools for performance evaluation (e.g., ROI, residual income).
Discuss the impact of performance evaluation on decision making.
Prepare and explain the flow of cash as relating to operating, investing, and financing activities, free cash flow, and the impact that it has on decision making.
Learning Resources
A local PBS station has decided to produce a TV series on state-of-the-art manufacturing. The director of the TV series, Justin Tyme, is currently attempting to analyze some of the projected costs for the series.
Tyme intends to take a TV production crew on location to shoot various manufacturing scenes as they occur.
If the four-week series is shown in the 8:00-9:00 P.M. prime-time slot, the station will have to cancel a wildlife show that is currently scheduled.
Management projects a 10% viewing audience for the wildlife show, and each 1% is expected to bring in donations of $10,000.
In contrast, the manufacturing show is expected to be watched by 15% of the viewing audience. However, each 1% of the viewership will likely generate only $5,000 in donations.
If the wildlife show is canceled, it can be sold to network television for $25,000.
Using the cost terminology introduced in this chapter, comment on each of the financial amounts mentioned in this scenario.
What are the relative merits of the two shows regarding the projected revenue to the station?
Based on your learning, what decision would you make and why?
Full Answer Section
Expense
An
expense is a cost that has been incurred and paid or is due to be paid. It is a reduction in equity or an outflow of cash.
Costs on Financial Statements
- Income Statement: Product costs are included in the cost of goods sold, while period costs are listed as operating expenses.
- Balance Sheet: Product costs are included in inventory, while period costs are expensed in the period incurred.
- Statement of Cash Flows: Costs are classified as operating, investing, or financing activities based on their nature.
Manufacturing Cost Flows
The flow of costs through the manufacturing process involves the following steps:
- Raw Materials: Purchase of raw materials and their storage.
- Work in Process: Conversion of raw materials into finished goods.
- Finished Goods: Completed goods ready for sale.
- Cost of Goods Sold: The cost of goods sold during a period.
Product Cost Determination
Product cost is determined by adding the cost of direct materials, direct labor, and manufacturing overhead.
- Direct Materials: The cost of materials that can be directly traced to the product.
- Direct Labor: The cost of labor directly involved in the production process.
- Manufacturing Overhead: Indirect costs, such as factory rent, utilities, and depreciation of manufacturing equipment.
Impact of Cost Flow and Product Cost on Decision Making
The flow of costs and product cost have a significant impact on decision making. Accurate cost information is essential for pricing products, evaluating profitability, and making investment decisions.
Allocation of Overhead Costs
Overhead costs are allocated to products using various methods, such as:
- Direct Labor Hours: Allocates overhead based on the amount of direct labor hours used.
- Machine Hours: Allocates overhead based on the amount of machine hours used.
- Direct Materials Cost: Allocates overhead based on the direct materials cost.
- Activity-Based Costing (ABC): A more sophisticated method that allocates overhead costs based on specific activities that consume resources.
Performance Evaluation Tools
- Return on Investment (ROI): Measures the profitability of an investment relative to its cost.
- Residual Income: Measures the excess of operating income over a minimum required return on investment.
Impact of Performance Evaluation on Decision Making
Performance evaluation tools help managers assess the effectiveness of their decisions and identify areas for improvement. By using these tools, managers can make informed decisions about resource allocation, product pricing, and strategic planning.
Financial Analysis of the TV Series
Costs:
- Production Costs: Costs of filming, editing, and producing the series.
- Opportunity Cost: The lost revenue from canceling the wildlife show ($25,000).
Revenue:
- Manufacturing Show: Projected revenue of $75,000 (15% of viewership * $5,000 per 1%).
- Wildlife Show: Projected revenue of $100,000 (10% of viewership * $10,000 per 1%).
Decision:
From a financial perspective, it would be more profitable to continue airing the wildlife show. While the manufacturing show has a higher viewership, the revenue generated per viewer is significantly lower. Additionally, canceling the wildlife show results in a loss of $25,000 in revenue from selling it to network television.
However,
other factors, such as the potential long-term benefits of producing the manufacturing show or the alignment with the station's overall programming strategy, should also be considered in making a final decision.