3. 3
Manufacturing Costs
Direct materials
Materials used in the final product.
Direct labor
Labor costs that goes to fabrication of a product.
Manufacturing Overhead
In particular, indirect materials, indirect labor, maintenance and repairs on production
equipment, heat and light, property taxes, depreciation, insurance on manufacturing
facilities, and overtime payment.
Non-manufacturing Costs
Overhead
Heat and light, property taxes, depreciation, and similar items associated with selling
and administrative functions.
Marketing
Advertising, shipping, sales travel, sales commissions, and sales salaries.
Administrative
Executive compensation, general accounting, public relations, and secretarial support.
4. COST FLOWS AND CLASSIFICATIONS IN
MANUFACTURING COMPANY
4
5. 5
Matching Concept: The costs incurred to generate particular revenue
should be recognized as expenses in the same period that the revenue
is recognized.
Period costs: Those costs that are charged to expenses in the period
in which the expenses are incurred. Examples of periodic costs are all
general and administrative expenses, selling expenses, insurance,
and income tax expenses. Therefore, advertising costs, executive
salaries, sales commissions, public relations costs, and other non-
manufacturing costs would all be period cost. Such costs are not
related to the production and flow of manufactured goods, but deducted
from revenue in the income statement.
Product costs: Those costs involved in the purchase or manufacturing
of goods. In the case of manufactured costs consist of direct materials,
direct labor, and manufacturing overhead. Product costs are not
viewed as expenses; rather they are the cost of creating inventory.
Thus, product costs are considered an asset until goods are sold.
6. 6
Cost Classification for Predicting Cost
Behavior
Volume index
Operating cost respond in some
way to changes in its operating
volume.
Cost Behaviors
Fixed costs
Variable costs
Mixed costs
In the car case, Depreciation,
occur from passage of time
(fixed portion) and also More
miles are driven a year, loses its
Market value (variable portion),
cost of electrical power (lighting,
number of machine hours
worked).
Average unit costs
7. 7
Volume Index
Definition: The unit measure
used to define “volume” Based
on production inputs (tons of
coal processed, direct labor
hours used, or machine hours
worked).
Examples:
Automobile – “miles” driven
Electricity Generating plant
– “kWh” produced
Stamping machine – “parts”
stamped
8. 8
Fixed Costs
Definition: The costs of providing
a company’s basic operating
capacity are known as its fixed
costs or capacity costs. Must
have a relatively wide span of
output for which costs are
expected remain constant.
Fixed cost do not change within
a given time period although
volume may change. For car
example, the annual insurance,
property tax, license fee.
Cost behavior: Remain constant
over the relevant range.
9. 9
Variable Costs
Definition:
Costs that vary depending
on the level of production
or sales. In manufacturing,
direct labor and material
costs are major variable
costs.
Cost behavior:
Increase or decrease
proportionally according
to the level of volume
10. 10
Practice Problem
You have 3000 units to produce.
Total labor cost = $20,000
Total material cost = $25,000
Total overhead cost = $15,000
Total fixed cost = $40,000
What is the average cost per unit?
Average cost = ($100,000)/3,000 = $33.33/unit
12. 12
Developing Project Cash Flow Statement
Income statement
Revenues
Expenses
Cost of goods sold
Depreciation
Debt interest
Operating expenses
Taxable income
Income taxes
Net income
Cash flow statement
+ Net income
+Depreciation
-Capital investment
+ Proceeds from sales of
depreciable assets
- Gains tax
- Investments in working
capital
+ Working capital recovery
+ Borrowed funds
-Repayment of principal
Net cash flow
Operating
activities
Investing
activities
Financing
activities
+
+
13. 13
Example 9.1 When Projects Require only Operating
and Investing Activities
• Project Nature: Installation of a new computer control system
• Financial Data:
– Investment: $125,000
– Project life: 5 years
– Working capital investment: $23,331
– Salvage value: $50,000
– Annual Revenues: $100,000
– Annual additional expenses:
• Labor: $20,000
• Material: $12,000
• Overhead: $8,000
– Depreciation Method: 7-year MACRS
– Income tax rate: 40%
– MARR: 15%
14. 14
Questions
(a) Develop the project’s cash flows over its project life.
(b) Is this project justifiable at a MARR of 15%?
(c) What is the internal rate of return of this project?
15. 15
When Projects Require Working Capital
Investments
Working capital represents the amount carried in cash,
accounts receivable, and inventory that are needed for the
operation of the project
Working Capital includes the stocks of finished and semi-
finished goods that will be economically consumed in the near
future or will be made into a finished consumer good in the
near future.
How to treat working capital investments: just like a capital
expenditure except that no depreciation is allowed.
21. 21
Cash Flow Diagram including Working Capital
0 1 2 3 4 5
$23,331
Years
$23,331
Working capital recovery cycles
0
1 2 3 4 5
$43,145
$48,245 $44,745
$42,245
$81,619
Working capital
recovery
$23,331
$125,000 Investment in
physical assets
$23,331 Investment in
working capital
$23,331
$23,331
22. 22
Question (b):
Is this investment justifiable at a
MARR of 15%?
PW(15%) = -$148,331 +
+$43,145(P/F, 15%, 1) + . . . .
+ $104,950 (P/F, 15%, 5)
= $31,423 > 0
Yes, Accept the Project !
0
1 2 3 4 5
$148,331
$43,145
$48,245 $44,745 $42,245
$104,950
Years
