LO16-1 through LO16-5 EXERCISE 16.1 Accounting Terminology Listed below are eight technical accounting terms introduced or emphasized in this chapter: Listed below are eight technical accounting terms introduced or emphasized in this chapter: 1) Work in Process 2) Inventory 3) Cost of finished goods manufactured 4) Conversion costs 5) Cost of Goods Sold 6) Period costs 7) Management accounting 8) Product costs 9) Manufacturing overhead Each of the following statements may (or may not) describe one of these technical terms. For each statement, indicate the accounting term described, or answer “None” if the statement does not correctly describe any of the terms. a. The preparation and use of accounting information designed to assist managers in planning and controlling the operations of a business. b. All manufacturing costs other than direct materials used and direct labor. c. Direct materials and direct labor used in manufacturing a product. d. A manufacturing cost that can be traced conveniently and directly to manufactured units of product. e. The account debited at the time that the Manufacturing Overhead account is credited. f. The amount transferred from the Work in Process Inventory account to the Finished Goods Inventory account. g. Costs that are debited directly to expense accounts when the costs are incurred. EXERCISE 16.2 (LO16-2) Basic Types of Manufacturing Costs Into which of the three elements of manufacturing cost would each of the following be classified? a. Tubing used in manufacturing bicycles. b. Wages paid by an automobile manufacturer to employees who test-drive completed automobiles. c. Property taxes on machinery. d. Gold bullion used by a jewelry manufacturer. e. Wages of assembly-line workers who package frozen food. f. Salary of plant superintendent. g. Electricity used in factory operations. h. Salary of a nurse in a factory first-aid station. EXERCISE 16.3 (LO16-3 & LO16-5) Product Costs and Period Costs Indicate whether each of the following should be considered a product cost or a period cost. If you identify the item as a product cost, also indicate whether it is a direct or an indirect cost. For example, the answer to item 0 is “indirect product cost.” Begin with item a. 0. Property taxes on factory building. a. Cost of disposal of hazardous waste materials to a chemical plant. b. Amounts paid by a mobile home manufacturer to a subcontractor who installs plumbing in each mobile home. c. Depreciation on sales showroom fixtures. d. Salaries of security guards in an administrative office building. EXERCISE 16.6 (LO16-3 & LO16-5) Flow of Costs through Manufacturing Accounts The Ryde and Rowe Inc. had the following account balances as of January 1: Direct Materials Inventory . . . .. . . . . . . . . . . . . . . . . . . . . . . . . $ 89,200 Work in Process Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178,400 Fin ...

1. LO16-1 through LO16-5
EXERCISE 16.1
Accounting Terminology
Listed below are eight technical accounting terms introduced or
emphasized in this chapter: Listed below are eight technical
accounting terms introduced or emphasized in this chapter:
1) Work in Process
2) Inventory
3) Cost of finished goods manufactured
4) Conversion costs
5) Cost of Goods Sold
6) Period costs
7) Management accounting
8) Product costs
9) Manufacturing overhead
Each of the following statements may (or may not) describe one
of these technical terms. For each statement, indicate the
accounting term described, or answer “None” if the statement
does not correctly
describe any of the terms.
a. The preparation and use of accounting information designed
to assist managers in planning and controlling the operations of
a business.
b. All manufacturing costs other than direct materials used and
direct labor.
c. Direct materials and direct labor used in manufacturing a
product.

2. d. A manufacturing cost that can be traced conveniently and
directly to manufactured units of product.
e. The account debited at the time that the Manufacturing
Overhead account is credited.
f. The amount transferred from the Work in Process Inventory
account to the Finished Goods Inventory account.
g. Costs that are debited directly to expense accounts when the
costs are incurred.
EXERCISE 16.2 (LO16-2)
Basic Types of
Manufacturing Costs
Into which of the three elements of manufacturing cost would
each of the following be classified?
a. Tubing used in manufacturing bicycles.
b. Wages paid by an automobile manufacturer to employees who
test-drive completed automobiles.
c. Property taxes on machinery.
d. Gold bullion used by a jewelry manufacturer.
e. Wages of assembly-line workers who package frozen food.
f. Salary of plant superintendent.
g. Electricity used in factory operations.

3. h. Salary of a nurse in a factory first-aid station.
EXERCISE 16.3 (LO16-3 & LO16-5)
Product Costs
and Period Costs
Indicate whether each of the following should be considered a
product cost or a period cost. If you identify the item as a
product cost, also indicate whether it is a direct or an indirect
cost. For example, the answer to item 0 is “indirect product
cost.” Begin with item a.
0. Property taxes on factory building.
a. Cost of disposal of hazardous waste materials to a chemical
plant.
b. Amounts paid by a mobile home manufacturer to a
subcontractor who installs plumbing in each mobile home.

4. c. Depreciation on sales showroom fixtures.
d. Salaries of security guards in an administrative office
building.
EXERCISE 16.6 (LO16-3 & LO16-5)
Flow of Costs through
Manufacturing Accounts
The Ryde and Rowe Inc. had the following account balances as
of January 1:

5. Direct Materials Inventory . . . .. . . . . . . . . . . . . . . . . . . . . . . .
. $ 89,200
Work in Process Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . .
. 178,400
Finished Goods Inventory . . . . . .. . . . . . . . . . . . . . . . . . . . . .
. 253,600
Manufacturing Overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. –0–
During the month of January, all of the following occurred:
1. Direct labor costs were $442,000 for 18,000 hours worked.
2. Direct materials costing $335,750 and indirect materials
costing $13,500 were purchased.
3. Sales commissions of $216,500 were earned by the sales
force.
4. $326,000 worth of direct materials were used in production.
5. Advertising costs of $36,300 were incurred.
6. Factory supervisors earned salaries of $22,000.
7. Indirect labor costs for the month were $23,000.
8. Monthly depreciation on factory equipment was $24,500.
9. Utilities expense of $17,800 was incurred in the factory.
10. Equipment with manufacturing costs of $970,100 were
transferred to finished goods.

6. 11. Monthly insurance costs for the factory were $4,200.
12. $5,000 in property taxes on the factory were incurred and
paid.
13. Equipment with manufacturing costs of $1,089,000 were
sold for $1,550,000.
Instructions
a. If Ryde and Rowe assigns manufacturing overhead of
$84,400, what will be the balances in the Direct Materials,
Work in Process, and Finished Goods Inventory accounts at the
end of January?
b. As of January 31, what will be the balance in the
Manufacturing Overhead account?
c. What was Ryde and Rowe’s operating income for January?

7. Reference Information for Each Exercise If needed.
LO16-1
LEARNING OBJECTIVE
Explain the three principles
guiding the design of
management accounting
systems.
MANAGEMENT ACCOUNTING’S ROLE IN ASSIGNING
DECISION-MAKING AUTHORITY
To achieve organizational goals, managers are assigned
decision-making authority for some of the firm’s assets. For
example, plant managers typically are responsible for decisions
about equipment in the plant, employees at the plant, the
physical plant layout, and sources of raw
materials, among other things. Within the plant, the materials
inventory manager may be delegated decision-making
responsibility for reordering materials, and the production
supervisor may be delegated decision-making responsibility for
assigning employees to jobs on the production
line. The point is that all members of an organization have some

8. decision-making authority. Employees within a corporation
know their decision-making responsibilities because they are
outlined in a variety of ways, such as in job descriptions, verbal
instructions from their supervisors, and management accounting
system documents and reports. Just as you have
received a course syllabus that outlines your instructor’s
standards for you to follow to earn an A or B in this course,
managers receive management accounting reports that outline
expected outcomes to help achieve the organization’s goals. Just
as you have decision-making responsibility over the “assets”
necessary to achieve an A or B (the time you allocate to
studying), managers have decision-making responsibility over
the assets included in their management accounting reports
MANAGEMENT ACCOUNTING’S ROLE
IN DECISION MAKING
Managers need reliable and timely information on which to base
their decisions. For example, the plant manager needs
information to help assess if equipment is inefficient or if
certain work arrangements and plant layouts are more
productive than others. Thus, managers need
both historical information (for example, the current
equipment’s cost and productivity) and projected information
(for example, the productivity and cost of other available
equipment). They need information oriented both toward their
specific operations and toward other parts of the organization’s
value chain. A value chain is the linked set of activities and
resources necessary to create and deliver the product or service
to the customer. Therefore, plant managers will require
information from other parts of the value chain such as
engineering or sales. They need information from both internal
operations and externally oriented benchmark sources. More and
more organizations are sharing information. It is very common
for organizations to participate in and undertake benchmark

9. studies . Independent consulting companies
often create benchmark reports by collecting information from
companies in the same industry. These studies show an
organization how its costs and processes compare with others in
its industry. Organizations also share information with
customers and suppliers in their value chain. For example, in
order for shipments from suppliers to arrive at the exact
time they are needed for use in production, buyers and suppliers
share their production information. Customers often require or
are voluntarily provided quality information. As shown in
Exhibit 16–1 , the management accounting system provides
past-, current-, and future- oriented information for users both
inside and outside the firm.
LO16-2 Describe the three basic types of
manufacturing costs.
CLASSIFICATIONS OF MANUFACTURING COSTS
A typical manufacturing company purchases raw materials and
converts these materials into finished goods through the process
of production. The costs of converting raw materials into
finished goods, specifically the direct labor and overhead costs,
are called conversion costs. In contrast, the direct materials and
direct labor that are consumed in production are referred to as
prime costs. Thus, direct labor is both a prime cost and a
conversion cost. These cost classifications are illustrated in
Exhibit 16–3 and described below.

10. The manufacturing costs are often divided into three broad
categories:
1. Direct materials —the raw materials and component parts
used in production whose costs are directly traceable to the
products manufactured.
2. Direct labor —wages and other payroll costs of employees
whose efforts are directly traceable to the products they
manufacture.
3. Manufacturing overhead —a catchall classification, which
includes all manufacturing costs other than the costs of direct
materials and direct labor. Examples include factory utilities,
supervisor salaries, equipment repairs, and depreciation on
production machinery.
Note that manufacturing costs are not immediately recorded as
current period expenses. Rather, they are costs of creating
inventory, and they remain on the balance sheet until the
inventory is sold. For this reason, manufacturing costs are often
called product costs (or inventoriable costs).

11. LO16-3 Distinguish between product costs and
period costs.
PRODUCT COSTS VERSUS PERIOD COSTS
The terms product costs and period costs are helpful in
explaining the difference between manufacturing costs and
operating expenses. In a manufacturing environment, product
costs are those costs incurred to manufacture inventory. Thus,
until the related goods are sold, product
costs represent inventory. As such, they are reported in the
balance sheet as an asset. When the goods are ultimately sold,
product costs are transferred from the balance sheet to the
income statement, where they are deducted from revenue as the
cost of goods sold. Operating expenses associated with time
periods, rather than with the production of inventory, are
referred to as period costs . Period costs are charged directly to
expense accounts on the assumption that their benefit is
recognized entirely in the period when the cost is incurred.
Period costs include all selling expenses, general and
administrative expenses, interest
expense, and income tax expense. In short, period costs are
classified in the income statement separately from cost of goods
sold, as deductions from a company’s gross profit.
The flow of product costs and period costs through The Home
Depot, Inc. financial statements is shown in Exhibit 16–4 .
EXHIBIT 16–4 “Flow” of Costs Through Financial Statements
To further illustrate the distinction between product and period
costs, consider two costs that, on the surface, appear quite

12. similar: the depreciation of a warehouse used to store raw
materials versus depreciation of a warehouse used to store
finished goods. Depreciation of the raw materials warehouse is
considered a product cost (a component of manufacturing
overhead) because the building is part of the manufacturing
process. Once the manufacturing process
is complete and the finished goods are available for sale, all
costs associated with their storage are considered selling
expenses. Thus, the depreciation of the finished goods
warehouse is a period cost.
INVENTORIES OF A MANUFACTURING BUSINESS
In the preceding example, assume all 10 houses were completed
by the end of the year. In this case, the developer’s inventory
consists only of finished goods. Most manufacturing companies,
however, typically account for three types of inventory:
1. Materials inventory —raw materials on hand and available

13. for use in the manufacturing process.
2. Work in process inventory —partially completed goods on
which production activities have been started but not yet
completed.
3. Finished goods inventory —unsold finished products
available for sale to customers. All three of these inventories
are classified on the balance sheet as current assets. The cost of
the materials inventory is based in its purchase price. The work
in process and finished goods inventories are based on the costs
of direct material, direct labor, and manufacturing
overhead assigned to them

14. LO16-5
LEARNING OBJECTIVE
Distinguish between direct
and indirect costs.
DIRECT AND INDIRECT MANUFACTURING COSTS
The costs of direct materials and direct labor may be traced
conveniently and directly to specific units of product. At
Conquest, for example, it is relatively easy to determine the
cost of the metal tubing and the cost of the direct labor that go
into making a particular bicycle. For this reason, accountants
call these items direct manufacturing costs. Overhead, however,
is an indirect manufacturing cost . Consider, for example, the
types of costs that Conquest classifies as overhead. These costs
include property taxes on the factory, depreciation on tools and
equipment, supervisors’ salaries, and repairs to equipment.
How much of these indirect costs should be assigned to each
bicycle? There is no easy answer to this question. By definition,
indirect costs cannot be traced easily and directly to specific
units of production. While these costs are often easier to view
as a whole than on a per-unit basis, we will see that both
financial and management accountants require unit cost
information. Therefore, manufacturing companies must develop
methods of allocating an appropriate portion of total
manufacturing overhead to each product manufactured. These
methods will be discussed in detail in Chapter 17.
WORK IN PROCESS INVENTORY, FINISHED GOODS
INVENTORY, AND THE COST OF GOODS SOLD
We have devoted much of this chapter to discussing the three
types of manufacturing costs direct materials, direct labor, and
manufacturing overhead. We will now shift our attention to the
three accounts that provide the structure for the flow of these

15. costs—the Work in Process
Inventory account, the Finished Goods Inventory account, and
the Cost of Goods Sold account.
The Work in Process Inventory account is used (1) to record the
accumulation of manufacturing costs associated with the units
of product worked on during the period and (2) to allocate these
costs between those units completed during the period and those
that are only partially completed.
Because direct materials, direct labor, and manufacturing
overhead are consumed in production, their related costs are
debited to the Work in Process Inventory account. The flow of
costs into this inventory account (rather than into a
corresponding expense account) is consistent
with the idea that manufacturing costs are product costs, not
period costs.
As specific units are completed, the cost of manufacturing them
is transferred from the Work in Process Inventory account to the
Finished Goods Inventory account. Thus, the balance in the
Work in Process account represents only the manufacturing
costs associated with
units still “in process.”
It is important to realize that once products are classified as
finished goods, no additional costs are allocated to them.
Therefore, the costs of storing, marketing, or delivering
finished goods are regarded as selling expenses, not
manufacturing costs. When units of finished goods are sold,
their related costs must “flow” from the balance sheet through
the income statement in compliance with the matching
principle. Accordingly, as products are sold, their costs are
transferred from the Finished Goods Inventory account to the
Cost of Goods Sold account.