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General Cost Classifications






Variable cost Product cost

Fixed cost Sunk cost

Prime cost Conversion cost

Opportunity cost Period cost

Choose the term or terms above that most appropriately describe the cost identified in each of the following situations. A cost term can be used more than once.

1. Lake Company produces a bag that is very popular with college students. The cloth going into the manufacture of the bag would be called direct materials and classified as a ________ cost. In terms of cost behaviour, the cloth could also be described as a ________ cost.

2. The direct labour cost required to produce the bags, combined with the manufacturing overhead cost involved, would be known as________ cost.

3. The company could have taken the funds that it has invested in production equipment and invested them in interest-bearing securities instead. The interest forgone on the securities would be called________ cost

4. Taken together, the direct materials cost and the direct labour cost required to produce bags would be called________ cost.

5. The company used to produce a smaller bag that was not very popular. Some three hundred of these smaller bags are stored in one of the company’s warehouses. The amount invested in these bags would be called a ________ cost.

6. The bags are sold through agents who are paid a commission on each bag sold. These commissions would be classified by Lake Company as a ________ cost. In terms of cost behaviour, commissions would be classified as a ________ cost.

7. Depreciation on the equipment used to produce the bags would be classified by Lake Company as a ________ cost. However, depreciation on any equipment used by the company in selling and administrative activities would be classified as ________ cost. In terms of cost behaviour, depreciation would probably be classified as a ________ cost.

8. A ________ cost is also known as a stock-related cost, since such costs go into the Work in Process stock account and then into the Finished Goods stock account before appearing on the profit and loss account as part of cost of goods sold.

9. The salary of Lake Company’s managing director would be classified as a ________ cost, since the salary will appear on the profit and loss account as an expense in the time period in which it is incurred.

10. Costs can often be classified in several ways. For example, Lake Company pays £ 5, 000 rent each month on its factory building. The rent would be part of manufacturing overhead. In terms of cost behaviour, it would be classified as a ________ cost. The rent can also be classified as a ________ cost and as part of________ cost.


General Cost Classifications

Costs are associated with all types of organizations – business, nonbusiness, manufacturing, retail and service. Generally, the kinds of costs incurred and the way in which these costs are classified depends on the type of organization involved. Management accounting is as applicable to one type of organization as to another. For this reason, we will consider in our discussion the cost characteristics of a variety of organizations - manufacturing, merchandising and service.

Our initial focus in this chapter is on manufacturing companies, since their basic activities include most of the activities found in other types of business organizations. Manufacturing companies such as Nokia, BMW and Kodak are involved in acquiring raw materials, producing finished goods, marketing, distributing, billing and almost every other business activity. Therefore, an understanding of costs in a manufacturing company can be very helpful in understanding costs in other types of organizations.

In this chapter, we develop cost concepts that apply to diverse organizations. For example, these cost concepts apply to fast-food outlets such as McDonalds, Pizza Hut and Burger King; TV companies such as Carlton and the BBC; consulting firms such as Pricewaterhousecoopers and McKinsey; and your local hospital. The exact terms used in these industries may not be the same as those used in manufacturing, but the same basic concepts apply. With some slight modifications, these basic concepts also apply to merchandising companies such as Tesco, Sainsbury, Next, The Gap and Virgin, that resell finished goods acquired from manufacturers and other sources. With that in mind, let us begin our discussion of manufacturing costs.

 


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