CHAPTER 2

Basic Cost Terms and Concepts

MULTIPLE CHOICE

Ans 1. Which of the following statements is true?

LO 1 A. The word “cost” has the same meaning in all situations in which it is
RC used.
B. Cost data, once classified and recorded for a specific application, can
then be used in any application.
C. Different cost concepts and classifications are used for different
purposes.
D. All organizations incur the same types of costs.
E. Costs incurred in one year are always meaningful in the following
year.

Ans 2. Variable costs are those costs that:

LO 2 A. vary inversely with changes in activity.
RC B. vary directly with changes in activity.
C. remain constant as activity changes.
D. decrease on a per-unit basis as activity increases.
E. increase on a per-unit basis as activity increases.

Ans 3. As activity decreases, unit variable cost:

LO 2 A. increases proportionately with activity.
RC B. decreases proportionately with activity.
C. remains constant.
D. increases by a fixed amount.
E. decreases by a fixed amount.

Ans 4. Which of the following is not an example of a variable cost?

LO 2 A. Straight-line depreciation on a machine expected to last five years.
N B. Piece-rate wages paid to manufacturing workers.
C. Tires used to produce tractors.
D. Lumber used to make patio furniture.
E. Commissions paid to sales personnel.

2-1
Ans 5. Fixed costs are those costs that:
LO 2 A. vary directly with changes in activity.
RC B. vary inversely with changes in activity.
C. remain constant on a per-unit basis.
D. increase on a per-unit basis as activity increases.
E. remain constant as activity changes.

Ans 6. The fixed costs per unit are $10 when a company produces 10,000 units of
LO 2 product. What are the fixed costs per unit when 12,500 units are produced?
A A. $4.
B. $6.
C. $8.
D. $10.
E. $12.

Ans 7. The variable costs per unit are $4 when a company produces 10,000 units of
LO 2 product. What are the variable costs per unit when 8,000 units are produced?
A A. $4.00.
B. $4.50.
C. $5.00.
D. $5.50.
E. $6.00.

Ans 8. Total costs are $80,000 when 8,000 units are produced; of this amount,
LO 2 variable costs are $48,000. What are the total costs when 10,000 units are
A produced?
A. $80,000.
B. $92,000.
C. $98,000.
D. $100,000.
E. $108,000.

Ans 9. Which of the following would likely be a cost driver for the amount of direct
LO 3 materials used?
N A. The number of units sold.
B. The number of direct labor hours worked.
C. The number of machine hours worked.
D. The number of employees working in the factory.
E. The number of units produced.

2-2
Ans 10. Costs that can be easily traced to a specific department are called:
LO 4 A. direct costs.
RC B. indirect costs.
C. product costs.
D. manufacturing costs.
E. processing costs.

Ans 11. Indirect costs:

LO 4 A. can be traced to a cost object.
RC, N B. cannot be traced to a particular cost object.
C. are not important.
D. are always variable costs.
E. may be indirect with respect to Disney World but direct with respect
to one its major components, Epcot Center.

Ans 12. Midwest Motors manufactures automobiles Which of the following would
LO 5 not be classified as direct materials by the company?
N A. Sheet metal used in the automobile’s body.
B. Tires.
C. Interior leather.
D. CD player.
E. Wheel lubricant.

Ans 13. Which of the following employees of a commercial printer/publisher would

LO 5 be classified as direct labor?
N A. Book binder.
B. Plant security guard.
C. Sales representative.
D. Plant supervisor.
E. Payroll supervisor.

Ans 14. Quality Appliance produces washers and dryers in an assembly-line process.
LO 5 Labor costs incurred during a recent period were: corporate executives,
A $100,000; assembly-line workers, $60,000; security guards, $11,000; and plant
supervisor, $18,000. The total of Quality’s direct labor cost was:
A. $60,000.
B. $71,000.
C. $78,000.
D. $89,000.
E. $189,000.

2-3
Ans 15. Depreciation of factory equipment would be classified as:
LO 5 A. operating cost.
RC B. “other” cost.
C. manufacturing overhead.
D. depreciation expense.
E. administrative cost.

Ans 16. Which of the following costs is not a component of manufacturing overhead?
LO 5 A. Indirect materials.
RC B. Factory utilities.
C. Factory equipment.
D. Indirect labor.
E. Property taxes on the manufacturing plant.

Ans 17. Conversion costs are:

LO 5 A. direct material, direct labor, and manufacturing overhead.
RC B. direct material and direct labor.
C. direct labor and manufacturing overhead.
D. prime costs.
E. period costs.

Ans 18. Prime costs are comprised of:

LO 5 A. direct materials and manufacturing overhead.
RC B. direct labor and manufacturing overhead.
C. direct materials, direct labor, and manufacturing overhead.
D. direct materials and direct labor.
E. direct materials and indirect materials.

Ans 19. Product costs are:

LO 6 A. expensed when incurred.
RC B. inventoried.
C. treated in the same manner as period costs.
D. always variable in nature.
E. always fixed in nature.

Ans 20. Which of the following would not be classified as a product cost?
LO 6 A. Direct materials.
RC, N B. Direct labor.
C. Indirect materials.
D. Insurance on the manufacturing plant.
E. Sales commissions.

2-4
Ans 21. Costs that are expensed when incurred are called:
LO 6 A. product costs.
RC B. direct costs.
C. inventoriable costs.
D. period costs.
E. indirect costs.

Ans 22. Which of the following is a period cost?

LO 6 A. Direct material.
N B. Advertising expense.
C. Depreciation on cars driven by a firm’s president and treasurer.
D. Miscellaneous supplies used in production activities.
E. Both B and C.

Ans 23. The accounting records of Ohio Corporation revealed the following selected
LO 6 costs: Sales commissions, $20,000; plant supervision, $84,000; and
A administrative expenses, $100,000. Ohio’s period costs total:
A. $20,000.
B. $84,000.
C. $100,000.
D. $120,000.
E. $204,000.

Ans 24. Selling and administrative expenses would likely appear on the balance sheet
LO 7 of:
N A. American Airlines.
B. Wal-Mart Corporation.
C. Dell Computer.
D. all of the above firms.
E. none of the above firms.

Ans 25. Which of the following entities would most likely have raw materials, work in
LO 7 process, and finished goods?
N A. Exxon Corporation.
B. Macy’s Department Store.
C. Wendy’s.
D. Southwest Airlines.
E. Columbia University.

Ans 26. Which of the following inventories would a company ordinarily hold for sale?
LO 7
RC A. Raw materials.
B. Work in process.
C. Finished goods.
D. Raw materials and finished goods.
E. Work in process and finished goods.
2-5
Ans 27. Which of the following statements is true?
LO 7 A. Product costs affect only the balance sheet.
N B. Product costs affect only the income statement.
C. Period costs affect only the balance sheet.
D. Period costs affect both the balance sheet and the income statement.
E. Product costs eventually affect both the balance sheet and the income
statement.

Ans 28. In a manufacturing company, the cost of goods completed during the period
LO 8 would include which of the following elements?
RC A. Raw materials used.
B. Beginning finished goods inventory.
C. Marketing costs.
D. Depreciation of office equipment.
E. More than one of the above.

Ans 29. Which of the following equations is used to calculate the cost of goods sold
LO 8 during the period?
RC A. Beginning finished goods + cost of goods manufactured + ending
finished goods.
B. Beginning finished goods - ending finished goods.
C. Beginning finished goods + cost of goods manufactured.
D. Beginning finished goods + cost of goods manufactured - ending
finished goods.
E. Beginning finished goods + ending finished goods - cost of goods
manufactured.

Ans 30. Work-in-process inventory is composed of:

LO 8 A. direct material and direct labor.
RC B. direct labor and manufacturing overhead.
C. direct material and manufacturing overhead.
D. direct material only.
E. direct material, direct labor, and manufacturing overhead.

Ans 31. Barrett Industries began June with a finished goods inventory of $15,000. The
LO 8 finished goods inventory at the end of June was $10,000 and the cost of goods
A sold during the month was $20,000. The cost of goods manufactured during
June was:
A. $5,000.
B. $15,000.
C. $20,000.
D. $25,000.
E. $35,000.

2-6
Ans 32. Kansas Plating Company reported a cost of goods manufactured of $260,000,
LO 8 with the firm’s year-end balance sheet revealing work in process and finished
A goods of $35,000 and $67,000, respectively. If supplemental information
disclosed direct materials used in production of $40,000, direct labor of
$70,000, and manufacturing overhead of $120,000, the company’s beginning
work in process must have been:
A. $5,000.
B. $37,000.
C. $65,000.
D. $97,000.
E. some other amount.

Ans 33. Pumpkin Enterprises began operations on January 1, 19x7, with all of its
LO 8 activities conducted from a single facility. The company’s accountant
A concluded that the year’s building depreciation should be allocated as
follows: selling activities, 20%; administrative activities, 35%; and
manufacturing activities, 45%. If Pumpkin sold 60% of 19x7 production
during that year, what percentage of the depreciation would appear (either
directly or indirectly) on the 19x7 income statement?
A. 27%.
B. 45%.
C. 55%.
D. 82%.
E. 100%.

Ans 34. An employee accidentally overstated the year’s advertising expense by

LO 8 $50,000. Which of the following correctly depicts the effect of this error?
A A. Cost of goods manufactured will be overstated by $50,000.
B. Cost of goods sold will be overstated by $50,000.
C. Both cost of goods manufactured and cost of goods sold will be
overstated by $50,000.
D. Cost of goods sold will be overstated by $50,000, and cost of goods
manufactured will be understated by $50,000.
E. None of the above.

Ans 35. The salary that is sacrificed by a college student who pursues a degree full
LO 9 time is a(n):
N A. sunk cost.
B. out-of-pocket cost.
C. opportunity cost.
D. differential cost.
E. marginal cost.

2-7
Ans 36. The tuition that is paid this semester by a college student who pursues a
LO 9 degree is a(n):
N A. sunk cost.
B. out-of-pocket cost.
C. opportunity cost.
D. average cost.
E. marginal cost.

Ans 37. If the total cost of alternative A is $50,000 and the total cost of alternative B is
LO 9 $34,000, then $16,000 is termed the:
N A. opportunity cost.
B. average cost.
C. sunk cost.
D. out-of-pocket cost.
E. differential cost.

Refer to the following data when solving multiple-choice questions 38 and 39.

Wee Care is a nursery school for pre-kindergarten children. The school has
determined that the following biweekly revenues and costs occur at different levels of
enrollment:

Number of Students Enrolled Total Revenue Total Costs

10 $ 3,000 $ 2,100
15 4,500 2,700
16 4,800 2,800
20 6,000 3,200
21 6,300 3,255

Ans 38. The marginal cost when the twenty-first student enrolls in the school is:
LO 9 A. $55.
A B. $155.
C. $300.
D. $3,045.
E. $3,255.

Ans 39. The average cost per student when 16 students enroll in the school is:
LO 9 A. $100.
A B. $125.
C. $175.
D. $300.
E. $400.

2-8
Ans 40. Which of the following costs should be ignored when choosing among
LO 10 alternatives?
RC A. Opportunity costs.
B. Sunk costs.
C. Out-of-pocket costs.
D. Differential costs.
E. None of the above.

EXERCISES

Fixed and Variable Cost Behavior

LO 2 41. Mighty Muffler, Inc., operates an automobile service facility. The table below
A shows the cost incurred during a month when 600 mufflers were replaced.

Number of Muffler Replacements

500 600 700
Total costs:
Fixed costs $ 8 400 $ 8,400 $ 8 400
Variable costs 5 000 6,000 7 000
Total costs 13 400 $14,400 15 400
Cost per muffler replacement:
Fixed cost 16.80 14.00 12.00
Variable cost 26.80 24.00 22.00
Total cost per muffler replacement 43.60 38.00 34.00

REQUIRED:
Fill in the missing amounts, labeled A through O, in the table.
 VARIABLE COST ($ 6 000/ 600= $ 10)

A. $ 8 400
B. 500 * $ 10= $ 5000
C. $ 8 400
D. 700 * $10= $ 7000
E. $ 8 400 + 5 000= $ 13 400
F. $ 8 400 + 7 000= $ 15 400
G. $ 8 400 / 500 = $ 16.80
H. $ 8400 / 600 = $ 14.00
I. $ 8 400 / 700 = $ 12. 00
J. $ 13 400 / 500 = $ 26.80
K. $ 14 400 / 600 = $ 24.00
L. $ 15 400 / 700 = $ 22. 00
2-9
M. $ 16.80 + 26.80 = $ 43.60
N. $ 14.00 + 24.00 = $ 38.00
O. $ 12.00 + 22.00 = $ 34.00

Identification of Product Costs and Period Costs, Cost Behavior

LO 2, 42. Eastside Manufacturing produces small electric engines. Identify the

5, 6 following costs as direct materials (DM), direct labor (DL), manufacturing
N overhead (MOH), or a period cost (PC). Also indicate whether the cost is
variable (V) or fixed (F) with respect to behavior.

A. Commissions paid to salespeople MOH- F

B. Straight-line depreciation on the factory building PC-F
C. Salary of the plant supervisor DL-F
D. Wages of the assembly-line workers MOH- F
E. Machine lubricant used in production activities DM-V
F. Engine casings used in production activities DM-V
G. Advertising placed in trade journals PC-F
H. Lease payments for the president’s automobile PC-F
I. Property taxes paid on the factory facilities PC-F

Identification of Various Cost Concepts

LO 4, 43. The following selected costs were extracted from the accounting records of
5, 6, 8 Los Angeles Machining (LAM):
N
1. Direct materials used in production
2. Wages of machine operators
3. Factory utilities
4. Sales commissions
5. Salary of LAM’s president
6. Factory depreciation
7. Wages of plant security guards
8. Uncollectible accounts expense
9. Machine lubricant used in production

REQUIRED:
By the use of numbers, identify the costs that would be used to calculate:
A. cost of goods manufactured.
1. DIRECT MATERIALS USED IN PRODUCTION
2. WAGES OF MACHINE OPERATORS
3. WAGES OF PLANT SECURITY GUARDS
4. MACHINE LUBRICANT USED IN PRODUCTION
2-10
B. manufacturing overhead.
1. WAGES OF PLANT SECURITY GUARDS
C. total period costs.
1. FACTORY UTILITIES
2. SALES COMMISIONS
3. SALARY OF LAMS PRESIDENT
4. FACTORY DEPRECIATION
5. UNCOLLECTIBLE ACCOUNTS EXPENSE
D. total conversion costs.
1. WAGES OF MACHINE OPERATOR
2. WAGES OF PLANT SECURITY GUARDS
E. total direct costs of LAM’s credit and collections department.
1. DIRECT MATERIALS USED IN PRODUCTION
2. WAGES OF MACHINE OPERATORS
3. WAGES OF PLANT SECURITY GUARDS
4. MACHINE LUBRICANT USED IN PRODUCTION
F. LAM’s inventory valuation.
1. DIRECT MATERIALS USED IN PRODUCTION
2. MACHINE LUBRICANT USED IN PRODUCTION

2-11
Cost of Goods Manufactured and Cost of Goods Sold
LO 8 44. Perez Manufacturing had the following data for the period just ended:
A

Work in process, Jan. 1 $ 15,000

Work in process, Dec. 31 25,000
Finished goods, Jan. 1 60,000
Finished goods, Dec. 31 40,000
Direct materials used 120,000
Direct labor 220,000
Factory depreciation 68,000
Sales 800,000
Advertising expense 44,000
Factory utilities 25,000
Indirect materials 19,000
Indirect labor 33,000

REQUIRED:
Calculate Perez’s (1) cost of goods manufactured and (2) cost of goods sold.

1. WORK IN PROCESS, JAN 1 $ 15 000

DIRECT MATERIALS USED $120 000
DIRECT LABOR 220 000
INDIRECT MATERIALS 19 000
INDIRECT LABOR 33 000 392 000
TOTAL 407 000
LESS:
WORK IN PROCESS, DEC 31 25 000
COSTS OF GOODS MANUFACTURED $ 382 000

2. FINISHED GOODS, JAN 1 $ 60 000

COSTS OF GOODS MANUFACTURED 382 000
GOODS AVAILABLE FOR SALE 442 000
LESS:
FINISHED GOODS, DEC 31 40 000
COSTS OF GOODS SOLD $ 402 000

2-12
Flow of Costs─Missing Values

LO 8 45. The Wizz-Bang Company recorded the following transactions for February
A 19x9:

Work in Finished
Materials Process Goods
Purchases $100,000
Beginning inventory 18,000 $ 8,000 $ 157 000
Ending inventory $18 000 20,000 20,000
Direct materials used 90,000
Direct labor $ 80 000
Manufacturing overhead (includes
indirect materials of $10,000) 115,000
Transferred to finished goods $273 000
Cost of goods sold $400 000

Sales were $560,000, with sales prices determined by adding a 40% markup
to the firm’s manufacturing cost. The total cost of direct materials, direct labor,
and manufacturing overhead during the month was $285,000.

REQUIRED:
Calculate the missing values.

A. BEG. INVENTORY $ 18 000

PURCHASES 100 000
TOTAL 118 000
LESS:
DIRECT MATERIAL 90 000
INDIRECT MATERIAL 10 000
END. INVENTORY $ 18 000

B. TOTAL MANUFACTURING OH $ 285 000

LESS:
DIRECT MATERIAL $ 90 000
MAN. OVERHEAD 115 000 205 000
DIRECT MATERIAL $ 80 000

C. BEGINNING WIP $ 8 000

TOTAL COSTS 285 000
TOTAL 293 000
LESS:
ENDING WIP 20 000
TRANSFERRED TO FG $ 273 000

2-13
D. SALES $ 560 000
DIVIDE BY 1.4
COGS $ 400 000

E. ENDING FG $ 20 000
ADD: COGS 400 000
LESS: TRANSFERRED TO FG 273 000
BEGINNING FG $ 147 000

Economic Characteristics of Costs

LO 9 46. The following terms are used to describe various economic characteristics of
N costs:

Opportunity cost Differential cost

Out-of-pocket cost Marginal cost
Sunk cost Average cost

REQUIRED:
Choose one of the preceding terms to characterize each of the amounts
described below.

A. The cost of including one extra child in a day-care center. MARGINAL

COST

B. The cost of merchandise inventory purchased five years ago, which is

now obsolete. SUNK COSTS

C. The cost of feeding 300 children in a public school cafeteria is $450 per
day, or $1.50 per child per day. What economic term describes this
$1.50 cost? AVERAGE COST

D. The management of a high-rise office building uses 3,000 square feet

of space in the building for its own management functions. This space
could be rented for $30,000. What economic term describes this
$30,000 of lost rental revenue? OPPORTUNITY COSTS

E. The cost of building an automated assembly line in a factory is

$700,000; a manually-operated assembly line would cost $250,000.
What economic term is used to describe the $450,000 variation
between these two amounts? DIFFERENTIAL COST

F. Refer to the preceding question and assume that the firm is currently
building the assembly line for $700,000. What economic term is used
to describe the $700,000 construction cost? OUT-OF-POCKET COSTS

2-14
DISCUSSION QUESTIONS

Behavior of Fixed and Variable Costs

LO 2 47. In discussing the operation of his automobile, a doctor once observed that
N gasoline is a fixed cost because the cost per gallon is relatively stable.
Insurance, on the other hand, is a variable cost because the cost per mile
varies inversely with the number of miles driven. Comment on the doctor’s
observation.

THE DOCTOR IDENTIFICATION WHETHER THE COST IS VARIABLE OR

FIXED IS INCORRECT. GASOLINE IS VARIABLE COST BECAUSE THE
PRICE VARY DEPENDING ON THE LITER. WHILE INSURANCE IS A FIXED
COST. THE INSTALLMENT/ AMOUNT OF MONEY PAID IS EQUAL
MONTHLY/ YEARLY.

Definition of Cost Terms

LO 4, 5 48. Define each of the following terms and distinguish between the terms in each
RC pair.
A. Direct and indirect costs
DIRECTS COSTS ARE COSTS WHICH IS DIRECTLY TRACEABLE TO
COST OBJECT. ON THE OTHER HAND, INDIRECT COSTS ARE
COSTS THAT ARE NOT DIRECTLY TRACEABLE TO COST OBJECT.
B. Direct materials and indirect materials
DIRECT MATERIALS ARE THE RAW MATERIALS THAT IS PUT INTO
PRODUCTION WHICH IS AN INTEGRAL PART OF THE PRODUCT.
WHILE INDIRECT MATERIALS ARE THOSE THAT ARE USED IN
THE PRODUCTION BUT IS NOT AN INTEGRAL PART OF THE MAIN
PRODUCT.
C. Manufacturing overhead and direct labor
MANUFACTURING OVERHEAD IS THE COMBINATION OF
INDIRECT MATERIALS AND INDIRECT LABOR. THESE COSTS ARE
USUALLY NOT THE MAIN COST IF THE PRODUCT BUT THEY ARE
INCURRED IN THE PRODUCTION. DIRECT LABOR IS THE COSTS
OF SALARIES OF PEOPLE WORKING IN THE MANUFACTURING
COMPANY.

2-15
Product Costs and Period Costs
LO 6 49. Madison Corporation has a single facility that it uses for manufacturing, sales,
N and administrative activities. Should the company’s building depreciation
charge be expensed in its entirety or is a different accounting procedure
appropriate? Explain.
THE DEPRECIATION SHOULD BE EXPENSED SEPERATELY. SALES AND
ADMINISTRATIVE MUST BE EXPENSED WHEN INCURRED.
MANUFACTURING MUST BE PART OF PRODUCT COST.

Product Costs and Period Costs, Cost Flows

LO 6, 7 50. Manufacturers have established a cost classification called product costs.

RC Define the term “product cost” and note where these costs appear in the
financial statements. Be specific.
PRODUCT COSTS IS THE COST OF GOODS MANUFACTURED OR
RESALE. THEY APPEAR IN THE INCOME STATEMENT AS COSTS OF
GOODS SOLD.

Economic Characteristics of Costs, Relevance for Decisions

LO 9, 51. Describe the economic characteristics of sunk costs and opportunity costs, and
10 explain the impact that these costs may have on decisions.
RC SUNK COSTS REFERS TO THE COST EXPENSED IN THE PAST.
THEREFORE, IN MAKING DECISION THEY ARE NOT IMPORTANT.
OPPORTUNITY COSTS IS THE BENEFIT FORGONE WHEN CHOOSING
ANOTHER CHOICE, SO THIS MUST BE HELPFUL IN MAKING DECISION.

2-16