Cost Terms, Concepts and Classifications Chapter Two

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Learning Objective 1Identify and give examples of each of the three basic manufacturing cost categories.

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The ProductDirect MaterialsManufacturing Costs

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Direct Materials Raw materials that become an integral part of the product and that can be conveniently traced directly to it.Example: A radio installed in an automobile

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Direct LaborThose labor costs that can be easily traced to individual units of product.Example: Wages paid to automobile assembly workers

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Manufacturing costs that cannot be traced directly to specific units produced.Manufacturing OverheadExamples: Indirect labor and indirect materialsMaterials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.

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Non-manufacturing CostsSelling CostsCosts necessary to get the order and deliver the product.Administrative CostsAll executive, organizational, and clerical costs.

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Learning Objective 2Distinguish between product costs and period costs and give examples of each.

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Product Costs Versus Period Costs Product costs include direct materials, direct labor, and manufacturing overhead.Period costs include all selling costs and administrative costs. InventoryCost of Good SoldBalance SheetIncome StatementSaleExpenseIncome Statement

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Quick Check Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.C. Direct materials costs.D. Electrical costs to light the production facility.E. Sales commissions.

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Quick Check Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.C. Direct materials costs.D. Electrical costs to light the production facility.E. Sales commissions.

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Classifications of CostsDirect MaterialDirect LaborManufacturing OverheadPrime CostConversion CostManufacturing costs are often classified as follows:

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Comparing Merchandising and Manufacturing ActivitiesMerchandisers . . .Buy finished goods.Sell finished goods. Manufacturers . . .Buy raw materials.Produce and sell finished goods.

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Balance Sheet Merchandiser Current assetsCashReceivablesPrepaid ExpensesMerchandise Inventory Manufacturer Current AssetsCashReceivablesPrepaid ExpensesInventoriesRaw MaterialsWork in ProcessFinished Goods

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Learning Objective 3Prepare an income statement including calculation of the cost of goods sold.

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The Income Statement Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.

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Manufacturing Company

Cost of goods sold:

Beg. finished

goods inv.14,200

+ Cost of goods

manufactured$234,150

Goods available

for sale248,350

- Ending

finished goods

inventory$(12,100)

= Cost of goods

sold236,250

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Merchandising Company

Cost of goods sold:

Beg. merchandise

inventory14,200

+ Purchases$234,150

Goods available

for sale248,350

- Ending

merchandise

inventory$(12,100)

= Cost of goods

sold236,250

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Basic Equation for Inventory AccountsBeginningbalanceAdditions to inventory+=EndingbalanceWithdrawals frominventory+

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Quick Check If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month? A. $1,000.B. $ 800.C. $1,200.D. $ 200.

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Quick Check If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month? A. $1,000.B. $ 800.C. $1,200.D. $ 200.$1,000 + $100 = $1,100$1,100 - $300 = $800

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Learning Objective 4Prepare a schedule of cost of goods manufactured.

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Schedule of Cost of Goods ManufacturedCalculates the cost of raw material, direct labor and manufacturing overhead used in production.Calculates the manufacturing costs associated with goods that were finished during the period.

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As items are removed from raw materials inventory and placed into the production process, they are called direct materials. Product Cost Flows

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ManufacturingWork

Raw MaterialsCostsIn ProcessFinished Goods

Beginning rawDirect materialsBeginning finished

materials inventorygoods inventory

+Raw materials+Cost of finished

purchasedgoods mfg.

=Raw materials=Finished goods

available for useavailable for sale

in production-Ending finished

Ending raw materialsgoods inventory

inventory=Cost of finished

=Raw materials usedgoods sold

in production

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Product Cost Flows

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ManufacturingWork

Raw MaterialsCostsIn ProcessFinished Goods

Beginning rawDirect materialsBeginning finished

materials inventory+Direct laborgoods inventory

+Raw materials+Mfg. overhead+Cost of finished

purchased=Total manufacturinggoods mfg.

=Raw materialscosts=Finished goods

available for useavailable for sale

in production-Ending finished

Ending raw materialsgoods inventory

inventory=Cost of finished

=Raw materials usedgoods sold

in production

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Product Cost FlowsAll manufacturing costs incurred during the period are added to the beginning balance of work in process.

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ManufacturingWork

Raw MaterialsCostsIn ProcessFinished Goods

Beginning rawDirect materialsBeginning work inBeginning finished

materials inventory+Direct laborprocess inventorygoods inventory

+Raw materials+Mfg. overhead+Total manufacturing+Cost of finished

purchased=Total manufacturingcostsgoods mfg.

=Raw materialscosts=Total work in=Finished goods

available for useprocess for theavailable for sale

in productionperiod-Ending finished

Ending raw materialsgoods inventory

inventory=Cost of finished

=Raw materials usedgoods sold

in production

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Product Cost FlowsCosts associated with the goods that are completed during the period are transferred to finished goods inventory.

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ManufacturingWork

Raw MaterialsCostsIn ProcessFinished Goods

Beginning rawDirect materialsBeginning work inBeginning finished

materials inventory+Direct laborprocess inventorygoods inventory

+Raw materials+Mfg. overhead+Total manufacturing+Cost of finished

purchased=Total manufacturingcostsgoods mfg.

=Raw materialscosts=Total work in=Finished goods

available for useprocess for theavailable for sale

in productionperiod-Ending finished

Ending raw materialsEnding work ingoods inventory

inventoryprocess inventory=Cost of finished

=Raw materials used=Cost of goodsgoods sold

in productionmanufactured

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Product Cost Flows

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Work

In ProcessFinished Goods

Beginning work inBeginning finished

process inventorygoods inventory

+Manufacturing costs+Cost of goods

for the periodmanufactured

=Total work in process=Cost of goods

for the periodavailable for sale

Ending work in-Ending finished

process inventorygoods inventory

=Cost of goodsCost of goods

manufacturedsold

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Manufacturing Cost FlowsFinished GoodsCost of Goods SoldSelling and AdministrativePeriod CostsSelling and AdministrativeManufacturing Overhead Work in ProcessDirect Labor Balance Sheet Costs Inventories Income Statement ExpensesMaterial PurchasesRaw Materials

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Quick Check Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used? A.$276,000B.$272,000C.$280,000D.$ 2,000

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Quick Check Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used? A.$276,000B.$272,000C.$280,000D.$ 2,000

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Beg. raw materials32,000

+Raw materials

purchased$276,000

=Raw materials available

for use in production308,000

Ending raw materials

inventory$28,000

=Raw materials used

in production280,000

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Quick Check Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month? A.$555,000B.$835,000C.$655,000D.Cannot be determined.

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Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month? A.$555,000B.$835,000C.$655,000D.Cannot be determined.

Quick Check

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Direct Materials280,000

+Direct Labor$375,000

+Mfg. Overhead$180,000

=Mfg. Costs Incurred

for the Month835,000

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Quick Check Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month? A.$1,160,000B.$ 910,000C.$ 760,000D.Cannot be determined.

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Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month? A.$1,160,000B.$ 910,000C.$ 760,000D.Cannot be determined.

Quick Check

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Beginning work in

process inventory125,000

+Mfg. costs incurred

for the period$835,000

=Total work in process

during the period960,000

Ending work in

process inventory$200,000

=Cost of goods

manufactured760,000

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Quick Check Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. And the ending finished goods inventory was $150,000. What was the cost of goods sold for the month? A. $ 20,000.B. $740,000.C. $780,000.D. $760,000.

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Quick Check Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. And the ending finished goods inventory was $150,000. What was the cost of goods sold for the month? A. $ 20,000.B. $740,000.C. $780,000.D. $760,000.$130,000 + $760,000 = $890,000$890,000 - $150,000 = $740,000

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Learning Objective 5Understand the differences between variable costs and fixed costs.

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Cost Classifications for Predicting Cost Behavior How a cost will react to changes in the level of activity within the relevant range.Total variable costs change when activity changes.Total fixed costs remain unchanged when activity changes.

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Variable Cost Your total long distance telephone bill is based on how many minutes you talk.Minutes TalkedTotal Long Distance Telephone Bill

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Variable Cost Per Unit The cost per long distance minute talked is constant. For example, 10 cents per minute.

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Fixed Cost Your monthly basic telephone bill probably does not change when you make more local calls.

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Fixed Cost Per UnitThe average fixed cost per local call decreases as more local calls are made.

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Cost Classifications for Predicting Cost Behavior

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Behavior of Cost (within the relevant range)

CostIn TotalPer Unit

VariableTotal variable cost changesVariable cost per unit remains

as activity level changes.the same over wide ranges

of activity.

FixedTotal fixed cost remainsAverage fixed cost per unit goes

the same even when thedown as activity level goes up.

activity level changes.

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Quick Check Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store.B. The wages of the store manager.C. The cost of ice cream.D. The cost of napkins for customers.

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Quick Check Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store.B. The wages of the store manager.C. The cost of ice cream.D. The cost of napkins for customers.

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Learning Objective 6Understand the differences between direct and indirect costs.

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Assigning Costs to Cost ObjectsDirect costsCosts that can be easily and conveniently traced to a unit of product or other cost object.Examples: direct material and direct laborIndirect costsCosts that cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead

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Learning Objective 7Define and give examples of cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.

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Every decision involves a choice between at least two alternatives. Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits can and should be ignored.Cost Classifications for Decision Making

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Differential Cost and RevenueCosts and revenues that differ among alternatives. Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month. Differential revenue is: $2,000 $1,500 = $500Differential cost is: $300

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Opportunity Cost The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending college, you could be earning $15,000 per year. Your opportunity cost of attending college for one year is $15,000.

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Sunk Costs Sunk costs have already been incurred and cannot be changed now or in the future. They should be ignored when making decisions. Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.

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Quick Check Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you dont want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? A. Yes, the cost of the train ticket is relevant.B. No, the cost of the train ticket is not relevant.

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Quick Check Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you dont want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? A. Yes, the cost of the train ticket is relevant.B. No, the cost of the train ticket is not relevant.

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Quick Check Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you dont want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? A. Yes, the licensing cost is relevant.B. No, the licensing cost is not relevant.

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Quick Check Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you dont want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? A. Yes, the licensing cost is relevant.B. No, the licensing cost is not relevant.

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Quick Check Suppose that your car could be sold now for $5,000. Is this a sunk cost? A. Yes, it is a sunk cost.B. No, it is not a sunk cost.

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Quick Check Suppose that your car could be sold now for $5,000. Is this a sunk cost? A. Yes, it is a sunk cost.B. No, it is not a sunk cost.

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Summary of the Types of Cost ClassificationsFinancial reportingPredicting cost behaviorAssigning costs to cost objectsDecision making

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End of Chapter 2

3-**Managers need to rely upon different classifications of costs for different purposes. The four main purposes emphasized in this chapter include preparing external financial reports, predicting cost behavior, assigning costs to cost objects, and making business decisions. Our initial focus is on manufacturing companies since their basic activities include most of the activities found in other types of business organizations. Nonetheless, many of the concepts developed in this chapter apply to diverse organizations.

3-**Learning objective number 1 is to identify and give examples of each of the three basic manufacturing cost categories.3-**Manufacturing costs are usually grouped into three main categories: direct materials, direct labor, and manufacturing overhead. These costs are incurred to make a product.

3-**Direct materials are raw materials that become an integral part of the finished product and whose costs can be conveniently traced to it. Examples include the aircraft engines on a Boeing 777, the Intel processing chip in a personal computer, the blank video cassette in a pre-recorded video, and a radio in an automobile.

3-**Direct labor consists of that portion of labor cost that can be easily traced to a product. Direct labor is sometimes referred to as touch labor, since it consists of the costs of workers who touch the product as it is being made.

3-**Manufacturing overhead consists of all manufacturing costs, other than direct materials and direct labor. These costs cannot be conveniently traced to products. Such costs are also called indirect manufacturing costs, factory overhead, and factory burden. Examples include miscellaneous supplies such as rivets in a Boeing 777; salaries for supervisors, janitors, and security guards; factory facility charges, etc. 3-**A manufacturing company incurs many other costs in addition to manufacturing costs. For financial reporting purposes, most of these other costs are typically classified as selling costs and administrative costs. These costs are also called selling, general and administrative costs, or SG&A. Selling and administrative costs are incurred in both manufacturing and merchandising firms.

Selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customer. These costs are also referred to as order-getting and order-filling costs. Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehousing.

Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization. Examples of administrative costs include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall general administration of the organization as a whole. 3-**Learning objective number 2 is to distinguish between product costs and period costs and give examples of each.3-**Costs can also be classified as period or product costs.

Product costs include all the costs that are involved in acquiring or making a product. More specifically, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle, product costs are recognized as expenses when the products are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and when it appears as an expense on the income statement. Product costs are also known as inventoriable costs. The discussion in the chapter follows the usual interpretation of GAAP in which all manufacturing costs are treated as product costs.

Period costs include all selling costs and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are incurred when they are earned by the employees and not necessarily when they are paid to employees.

3-**Which of the following costs would be considered a period rather than a product cost in a manufacturing company?

3-**Property taxes on corporate headquarters and sales commissions are period costs. All of the other costs listed are product costs.3-**Two more cost categories are often used in discussions of manufacturing costsprime cost and conversion cost. Prime cost is the sum of direct materials cost and direct labor cost. Conversion cost is the sum of direct labor cost and manufacturing overhead cost. The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product.3-**Merchandising companies purchase finished goods from suppliers for resale to customers. Manufacturing companies purchase raw materials from suppliers and produce and sell finished goods to customers.

3-**Now, lets consider similarities and differences on the balance sheet for merchandising and manufacturing companies. Both merchandising and manufacturing companies will likely have Cash, Receivables and Prepaid Expenses. However, merchandising companies do not have to distinguish between raw materials, work in process, and finished goods. They report one inventory number on their balance sheets, labeled merchandise inventory. Manufacturing companies report three types of inventory on their balance sheets: raw materials, work in process and finished goods.

3-**Learning objective number 3 is to prepare an income statement including calculation of the cost of goods sold.3-**Merchandising companies calculate cost of goods sold as Beginning Merchandise Inventory plus Purchases minus Ending Merchandise Inventory.

For manufacturing companies, the cost of goods sold for a period is not simply the manufacturing costs incurred during the period. Manufacturing companies calculate cost of goods sold as Beginning Finished Goods Inventory plus Cost of Goods Manufactured minus Ending Finished Goods Inventory. Some of the cost of goods sold may be for units completed in a previous period. And some of the units completed in the current period may not have been sold and will still be on the balance sheet as assets. The cost of goods sold is computed with the aid of a schedule of costs of goods manufactured, which takes into account changes in inventories. The schedule of cost of goods manufactured is not ordinarily included in external financial reports, but must be compiled by accountants within the company in order to arrive at the cost of goods sold. We will learn more about a schedule of costs of goods manufactured later in this chapter. 3-**The computation of Cost of Goods Sold relies on this basic equation for inventory accounts. The logic underlying this equation applies to any inventory account. Any units that are in inventory at the beginning of the period appear as the beginning balance. During the period, additions are made to the inventory through purchases or other means. The sum of the beginning balance and the additions to the account is the total amount of inventory available. During the period, withdrawals are made from inventory. The ending balance is whatever is left at the end of the period after the withdrawals.

3-**If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month?3-**Right. $800. This is calculated as beginning inventory of $1,000 plus purchases of $100 minus ending inventory of $300.3-**Learning objective number 4 is to prepare a schedule of cost of goods manufactured.3-**The schedule of cost of goods manufactured contains the three elements of costs mentioned previously, namely direct materials, direct labor, and manufacturing overhead. It calculates the cost of raw material, direct labor and manufacturing overhead used in production. It also calculates the manufacturing costs associated with goods that were finished during the period.3-**To create a schedule of cost of goods manufactured, as well as a balance sheet and income statement, it is important to understand the flow of product costs. Raw material purchases made during the period are added to beginning raw materials inventory. The ending raw materials inventory is deducted to arrive at the raw materials used in production. As items are removed from the raw materials inventory and placed into the production process, they are called direct materials. 3-**Direct labor and manufacturing overhead (also called conversion costs) used in production are added to direct materials to arrive at total manufacturing costs.

3-**Total manufacturing costs are added to the beginning work in process to arrive at total work in process.

3-**The ending work in process inventory is deducted from the total work in process for the period to arrive at the cost of goods manufactured.

3-**The cost of goods manufactured is added to the beginning finished goods inventory to arrive at cost of goods available for sale. The ending finished goods inventory is deducted from this figure to arrive at cost of goods sold. 3-**Part IAll raw materials, work in process, and unsold finished goods at the end of the period are shown as inventoriable costs in the asset section of the balance sheet.

Part IIAs finished goods are sold, their costs are transferred to cost of goods sold on the income statement.

Part IIISelling and administrative expenses are not involved in making the product; therefore, they are treated as period costs and reported on the income statement for the period the cost is incurred.

3-**Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used?3-**Right. $280,000. Take a minute and review the solution before proceeding.3-**Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month?3-**Right. $835,000. Take a minute and review the solution before proceeding.3-**Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month?

3-**Right. $760,000. Take a minute and review the solution before proceeding.3-**Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. And the ending finished goods inventory was $150,000. What was the cost of goods sold for the month?

3-**Right. $740,000. Take a minute and review the solution before proceeding.3-**Learning objective number 5 is to understand the differences between variable costs and fixed costs.3-**Quite frequently, it is necessary to predict how a certain cost will behave in response to a change in activity. For example, a manager may want to estimate the impact that a 5% increase in sales would have on the companys total electric bill. Cost behavior refers to how a cost will react to changed in the level of activity within the relevant range. The most commonly used classifications of cost behavior are variable and fixed costs.

3-**A variable cost varies in direct proportion to changes in the level of activity. For example, your long distance telephone bill may be based on how many minutes your talkthe total bill varies with the number of minutes used. 3-**Although variable costs change in total as the activity level rises and falls, variable cost per unit is constant. For example, the cost per long distance minute may be ten cents a minute.3-**A fixed cost is constant within the relevant range. In other words, fixed costs do not change for changes in activity that fall within the relevant range. For example, your monthly basic telephone bill probably is a set amount and does not change based on the number of calls you make.3-**However, when expressed on a per unit basis, a fixed cost is inversely related to activitythe per unit cost decreases when activity rises and increases when activity falls. For example, the average fixed cost per local call decreases as more local calls are made.

3-**It is helpful to think about variable and fixed cost behavior in a two by two matrix, as illustrated here. Take a few minutes and review this summary of cost behavior for variable and fixed costs.3-**Which of the following costs would be variable with respect to the number of cones sold at a Baskins and Robbins shop? (There may be more than one correct answer.)

3-**Right. The cost of ice cream and the cost of napkins for customers would be variable costs. As Baskins and Robbins sells more ice cream cones, we would expect the total cost of ice cream and napkins to increase. 3-**Learning objective number 6 is to understand the differences between direct and indirect costs.3-**A cost object is anything for which cost data are desired including products, customers, jobs, organizational subunits, etc. For purposes of assigning costs to cost objects, costs are classified two ways:

Direct costs are costs that can be easily and conveniently traced to a specified cost object. Examples of direct costs are direct material and direct labor.

Indirect costs are costs that cannot be easily and conveniently traced to a specified cost object. An example of an indirect cost is manufacturing overhead. 3-**Learning objective number 7 is to define and give examples of cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.3-**It is important to realize that every decision involves a choice between at least two alternatives. The goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision. Costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits are irrelevant and can and should be ignored. To make decisions, it is essential to have a grasp on three concepts: differential costs, opportunity costs, and sunk costs. 3-**Differential costs (or incremental costs) is a difference in cost between any two alternatives. Differential costs can be either fixed or variable. A difference in revenue between two alternatives is called differential revenue.

For example, assume you have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month. In this example, the differential revenue is $500 and the differential cost is $300.

3-**Opportunity cost is the potential benefit that is given up when one alternative is selected over another. These costs are not usually entered into the accounting records of an organization, but must be explicitly considered in all decisions. 3-**A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Since sunk costs cannot be changed and therefore cannot be differential costs, they should be ignored in decision making. While students usually accept the idea that sunk costs should be ignored on an abstract level, like most people, they often have difficulty putting this idea into practice.

3-**Take a minute and read the information on this slide. Should the cost of the train ticket affect the decision of whether you drive or take the train to Portland?

3-**Yes, it should because the cost of the train ticket is relevant.3-**Take a minute and read the information on this slide. Is the annual cost of licensing your car relevant in this decision?

3-**No, it is not because the licensing cost is not relevant.

3-**Suppose that your car could be sold now for $5,000. Is this a sunk cost?

3-**No, it is not a sunk cost.3-**We have looked at the cost classifications used for financial reporting, predicting cost behavior, assigning costs to cost objects, and making business decisions. Now, lets look at how to classify idle time, overtime, and fringe benefits.

3-**End of chapter 2.