Question

Discussion Questions for Module 1: Question 1: How do product costs affect the financial statements? How does the classification of product cost (as an asset vs. an expense) affect net income? Be specific. Question 2: Sam's Garage is trying to determine the cost of providing an oil change. Why would the average cost of this service be more relevant than the actual cost for each customer? Question 3: Because of seasonal fluctuations, Noble Corporation has a problem determining the unit cost of the products it produces. For example, high heating costs during the winter months causes per-unit cost to be higher than per-unit cost in the summer months even when the same number of units of product is produced. Suggest several ways that Noble can improve the computation of per-unit costs.

Answer 1

1. Product costs associated with goods that have not been sold are recorded in the inventory account. Inventory cost is shown on the balance sheet as an asset. The amount of total assets and net income will increase if a product cost is classified as an asset.

Product costs associated with goods that have been sold should be recorded in cost of goods sold account. Cost of goods sold account is a expense shown on the income statement. The amount of total assets and net income will decrease if a product cost is classified as an expense as opposed to being classified as an asset as mentioned above.

Eg - Cash, an asset on balance sheet is used to buy raw materials, which after going through a manufacturing process turns into inventory. When the same in kept in the warehouse, it is classified as an inventory asset on the balance sheet. When the inventory is sold to a customer, the costs moves from the balance sheet to the income statement under the cost of goods sold (COGS). COGS is subtracted from the selling price to compute gross profit of the sale.

2. The average cost of providing a service is more relevant for pricing decisions. Customers want standardized pricing in order to know the price of a service in advance. They do not want to wait until after a service is performed to know how much it costs. Average cost is also more relevant for performance evaluation and for control purposes. Knowing the actual cost of each service is usually of little value in evaluating cost efficiency and knowing when to take corrective action.

3. Unit cost is a crucial cost measure in the operational analysis of a company. Identifying and analyzing a company's unit costs is a quick way to check if a company is producing a product efficiently. In the given case, the difference in the per unit overhead cost is due to overhead costs that were incurred non-uniformly. Noble Corporation can improve the per unit cost by allocating the overhead at predetermined rate. We can see here that Noble Corporation is using the actual costing method which provides the actual rate per unit for every month. Normal costing solves this problem associated with actual costing. A cost system that measures overhead costs on a predetermined basis and uses actual costs for direct material and direct labor is called normal costing system. Predetermined overhead or activity rates are calculated at the beginning of the year and are used to apply overhead to production as the year goes on.Any difference between actual and applied overhead is handled as an overhead variance.