Managerial Accounting: Class 2

Article: The Data Centers - You are a financial analyst at the manufacturing company The Dainty Hooligan. You invested $50 million in data centers, but Amazon could perform all the tasks for a fraction of the cost. 1) Are the wages of the data center employees a product cost or a period cost? When is this cost expensed? 2) As a manufacturing firm, what are the 3 types of inventory this company would have? 3) Should the CEO consider the information in the final paragraph above when deciding whether to shut down the data centers? Why or why not? 4) Would you recommend that the CEO shut down the data centers? Why or why not?

1) Period, not related to manufacturing; Expensed immediately, not attached to inventory 2) Raw Material Inventory, Work in Progress Inventory, and Finished Goods Inventory 3) No, the time and money invested in creating the data centers is a sunk cost. 4) Yes, the company could substantially increase its profitability, and managing data centers is not this company's core competency. (Yeah, it sucks, but the CEO should be honest about otherwise engaging in a value-destroying activity.)

What is a cost?

A cost is a resource sacrificed or forgone to achieve a particular objective.

What is a cost object?

A cost object is anything to which you can assign a cost. - Tesla can measure the cost of producing a car - WashU can measure the cost of its IT department - Amazon can measure the cost of a customer

What is a direct cost?

A direct cost is a cost than can be easily traced to a cost object. - The cost of the aluminum used to produce a soda can is a direct cost of the soda can

What is an indirect cost?

An indirect cost can not be easily traced to a cost object. - The factory manager's salary is an indirect cost of the soda can

The Effects of _____: As companies replace employees with machines, direct labor costs _____ and manufacturing overhead _____. Thus, manufacturing overhead is becoming increasingly important.

Automation; decreases; increases

_____ Cost = Direct Labor + Manufacturing Overhead

Conversion

Conversion Cost = _____ _____ + _____ _____

Direct Labor; Manufacturing Overhead

The product is a combination of: _____ _____, _____ _____, and _____ _____.

Direct Material; Direct Labor; Manufacturing Overhead

Prime Cost = _____ _____ + _____ _____

Direct Materials; Direct Labor

What is direct labor?

Direct labor is the labor that built the product ("touch labor"). (E.g., the assembly line workers who build the car)

What are direct materials?

Direct materials are the raw materials used to create the product. (E.g., the steel used to build a car)

Manufacturing overhead includes: - _____ materials - _____ labor - _____ and _____ expense for the factory - _____ of factory building, machines, equipment

Indirect; Indirect; Insurance; utility; Depreciation

What is manufacturing overhead?

Manufacturing overhead is all other manufacturing costs; this includes the cost of indirect labor and indirect materials (not direct materials and direct labor). (E.g., the cost of WD-40, the wages of the factory's security guard, the factory's electric bill, depreciation for the factory.)

What is marginal cost?

Marginal cost is the cost to produce one additional unit.

Example: Let's say your friend Senthil is deciding whether to accept a job paying $40,000/year as a professional cuddler or a full-tuition scholarship for 2 years to get a master's in bagpiping. Senthil says, "I might as well do the master's degree since it's free." Is Senthil correct?

No, Snethil's opportunity cost of going to grad school is $80,000.

Is Chancellor Wrighton's salary easily traceable to the Olin Business School?

No, Wrighton oversees 5 colleges. It is an indirect cost.

Example: Your friend Kubo borrowed $100,000 in student loans to get a master's in puppetry. Kubo no longer wants to be a puppeteer, and would prefer to join TaskRabbit. "I have to become a puppeteer, otherwise the $100,000 was a waste of money". Is Kubo correct?

No, the $100,000 is a sunk cost.

What is opportunity cost?

Opportunity cost is the benefit forgone (given up) by choosing one alternative over another.

When are period costs expensed?

Period costs are expensed as they are incurred.

What are period costs?

Period costs do not pertain to manufacturing and are not capitalized to the company's inventory account.

_____ costs are all costs that are not product costs. They are _____ in the period they are incurred.

Period; expensed

_____ Cost = Direct Materials + Direct Labor

Prime

When are product costs expensed?

Product costs are expensed (through COGS) when the inventory is sold.

What are product costs?

Product costs are manufacturing costs that are capitalized to the company's inventory account.

How are manufacturing costs capitalized to inventory? (Tumbleweed Tiny Homes Example) 1) _____ _____ Inventory: Tumbleweed first purchases the lumber it will need to build a home (_____ materials) 2) _____ _____ _____ Inventory: Tumbleweed employees use the lumber to begin physically constructing the home (_____ labor). The factory also incurs other costs such as the electric bill (_____ _____). 3) _____ _____ Inventory: Tumbleweed finishes the home; the costs are transferred from _____ to Finished Goods Inventory - _____ _____ _____ _____: The _____ costs are expensed to COGS when the tiny home is sold and the customer drives it away.

Raw Materials; direct Work in Progress; direct; manufacturing overhead Finished Goods; WIP Cost of Goods Sold; product

Period Costs: - _____ costs: _____ paid to Tumbleweed's sales force; _____ or _____ expense for a sales office - _____ costs: The _____ of Tumbleweed's staff accountant; Rent or depreciation expense for the _____ HQ - Remember: Period costs are NOT related to manufacturing, and are expensed when _____.

Selling; Commissions; Rent or depreciation Administrative; salary; corporate incurred

What is sunk cost?

Sunk cost is a cost incurred in the past that cannot be changed by any future decision. A sunk cost is irrelevant to decision-making.

What are the three types of product costs?

The three types of product costs are: 1) Direct materials 2) Direct labor 3) Manufacturing overhead

Is Dean Taylor's salary easily traceable to the Olin Business School?

Yes, this is the only thing he manages. It is a direct cost.

Question: Are you, as a student, a cost object?

Yes. Olin can measure the cost of providing services to you during your time here.

(E2.2) 4. An example of Direct Labor would be: a. A worker on an assembly line who installs the doors on vehicles b. A janitor who keeps the factory clean c. A salesperson who sells the product and earns a commission d. A motivational speaker the company hires to pump up the workforce by repeatedly shouting at them, "You can do it!"

a. A worker on an assembly line who installs the doors on vehicles

(E2.1) 7. A cost object is anything for which you can measure a cost. a. True b. False

a. True

(E2.2) 9. Manufacturing companies have three different types of inventory: Raw Materials, Work in Process, and Finished Goods. a. True b. False

a. True

(E2.1) 3. A direct cost is: a. The total cost required to manufacture a product b. A cost that can be easily traced to a cost object c. A cost that has a direct effect on the company's profit in the current period

b. A cost that can be easily traced to a cost object

(E2.2) 7. Prime costs consist of: a. Manufacturing Overhead b. Direct Materials + Direct Labor c. Direct Materials + Manufacturing Overhead d. Direct Labor + Manufacturing Overhead

b. Direct Materials + Direct Labor

(E2.1) 8. Period costs are expensed only when inventory is sold. a. True b. False

b. False

(E2.2) 10. The salary of a manufacturing company's Chief Financial Officer would be considered Manufacturing Overhead because it is not a cost of Direct Materials or Direct Labor. a. True b. False

b. False

(E2.2) 11. The cost of indirect materials used to manufacture a car is NOT a product cost. a. True b. False

b. False

(E2.2) 12. A university just received its monthly electric bill. The electric bill would be considered Manufacturing Overhead. a. True b. False c. It depends

b. False (the university is not a manufacturer)

(E2.1) 4. An indirect cost is: a. A cost that has an indirect effect on the company's profit in the current period b. Synonymous with the term "period cost" c. A cost that can NOT be easily traced to a cost object d. I'm getting annoyed, it's almost like this whole course is about accounting

c. A cost that can NOT be easily traced to a cost object

(E2.1) 1. A cost is: a. The payment of money b. A fixed expense the company must cover to stay in business c. A resource sacrificed or forgone to achieve a particular objective

c. A resource sacrificed or forgone to achieve a particular objective

(E2.2) 2. Manufacturing Overhead: a. Is the sum of direct materials and direct labor b. Does not include labor costs c. Any manufacturing cost not included in direct materials or direct labor d. Any cost other than direct materials and direct labor costs

c. Any manufacturing cost not included in direct materials or direct labor

(E2.1) 6. Product costs are: a. The costs of producing and marketing a product b. The costs of developing, producing, and marketing a product c. Manufacturing costs that attach to the product

c. Manufacturing costs that attach to the product

(E2.2) 1. Which of the following is NOT a product cost? a. Manufacturing Overhead b. Direct Materials c. SG&A Expense d. Direct Labor e. The cocaine they used to put in Coca-Cola

c. SG&A Expense

(E2.2) 3. An example of Direct Materials would be: a. A roll of duct tape that a factory manager uses whenever a machine breaks down b. A printer the factory manager uses to print out financial data c. The leather used to make a hiking boot

c. The leather used to make a hiking boot

Product costs appear on the income statement as _____ _____ _____ _____ in the period in which the products were _____. This is true for _____ and _____ companies.

cost of goods sold; sold; merchandising; manufacturing

(E2.2) 8. Four years ago, your company paid $10 million to a high-profile consulting company and ultimately received a report called "Strategic Synergy Web 2.0" from the consulting firm. The $10 million your company paid for the consulting service is: a. A prime cost b. A conversion cost c. An opportunity cost d. A sunk cost

d. A sunk cost

(E2.1) 2. Which of the following could be a cost object? a. The marketing department at Walmart's corporate headquarters b. A battleship built by the British Navy c. An undergraduate student at Yale University d. All of the above

d. All of the above

(E2.2) 6. Conversion costs consist of: a. Manufacturing Overhead b. Direct Materials + Direct Labor c. Direct Materials + Manufacturing Overhead d. Direct Labor + Manufacturing Overhead

d. Direct Labor + Manufacturing Overhead

(E2.1) 5. Let's say we're trying to calculate the cost of manufacturing a tub of ice cream. The wages paid to a janitor who sweeps the floor at the ice cream factory would be a(n): a. Period cost b. Prime cost c. Direct cost d. Indirect cost e. I heard you give your classes ice cream, wake me when that day comes

d. Indirect cost

(E2.2) 5. All of the following would constitute Manufacturing Overhead EXCEPT: a. Property insurance for the factory b. Utility costs for the factory c. The salary of the factory manager d. The wages of laborers who build the company's product in the factory

d. The wages of laborers who build the company's product in the factory

Example: Overtime Premium If a custom furniture company is working on 100 jobs, it wouldn't be reasonable to assign more _____ labor costs to the jobs that just so happen to be worked on during employees' overtime hours. - Exception: If the overtime is caused by a specific rush order or something _____-_____ and directly related to that specific job, it makes sense to charge the overtime premium as direct labor to that job.

direct; non-random

An _____ is the cost incurred when an asset is used up or sold for the purpose of generating _____.

expense; revenue

Product costs are also known as _____ costs because they get attached to inventory.

inventoriable

An Important Point: Some people assume that all labor costs are immediately expensed. - For a _____-_____ firm, this is true - For a _____ firm, it depends on the nature of the labor provided. Labor that is a _____ cost (product cost) is attached to the _____; it is not expensed until the inventory is _____. Non-manufacturing labor (e.g., an accountant's salary) is _____ expensed.

non-manufacturing; manufacturing; manufacturing; inventory; sold; immediately

Period costs appear on the income statement as _____ _____ in the period in which they were _____. _____ and _____ expenses are an example of period costs.

operating expense; incurred; Selling; administrative

Caveat: For internal accounting purposes, some companies do not consider the _____ _____ or the cost of _____ time for direct laborers to be part of direct labor. Instead, these companies include the _____ _____ and/or _____ time as part of _____ _____.

overtime premium; idle; overtime premium; idle; manufacturing overhead

A _____ cost is a cost assigned to goods that were either purchased or manufactured for resale. Another term for product cost is _____ cost, since a product cost is stored in the cost of inventory until the goods are sold. In the period of the sale, the product costs are recognized as an _____ called cost of goods sold.

product; inventoriable; expense

Common cost objects include a _____ or _____, a _____ or _____, and a _____.

product; service; department; process; customer

Work In Progress: - Some of the Raw Materials Inventory is _____ (i.e., transferred to the WIP Inventory) - WIP Inventory consists of _____ completed units

reduced; partially

Example: Idle Time Idle time is wages paid for _____ time caused by lack of orders, machine breakdowns, poor scheduling, etc. - E.g., if a mechanic has to wait 2 hours for a part to arrive before he can continue working on a job, it doesn't make much sense to charge the 2 hours of labor to that job. Doing so would make the job seem more expensive tan the same job performed on a different day where the part happens to be in stock.

unproductive