Management Management

Accounting and Accounting and

Cost Concepts Cost Concepts
Management Management
Accounting and Accounting and
Cost Concepts Cost Concepts
Accy211: Management Accounting II Accy211: Management Accounting II
Autumn Session Autumn Session 2013 2013
Week 2 Week 2
1
Learning Objectives Learning Objectives
1. 1. Identify three basic manufacturing cost categories Identify three basic manufacturing cost categories
2. 2. Distinguish between product costs and period costs Distinguish between product costs and period costs
3. Understand the difference between Variable costs and
fixed costs
4 Understandthedifferencebetweendirect costsand
2
4. Understand the difference between direct costs and
indirect costs
5. 5. Prepare Prepare an income statement including calculation of the an income statement including calculation of the
cost of goods sold and a schedule of cost of goods cost of goods sold and a schedule of cost of goods
manufactured. manufactured.
6. 6. Define cost classifications used in making decisions: Define cost classifications used in making decisions:
differential costs, opportunity costs, and sunk costs. differential costs, opportunity costs, and sunk costs.
Learning Objective 1 Learning Objective 1
Id tif th b i Id tif th b i Identify three basic Identify three basic
manufacturing cost categories manufacturing cost categories
3
Direct
Materials
Direct
Labor
Manufacturing Manufacturing
Overhead
Manufacturing Costs Manufacturing Costs
The Product The Product
4
Direct Materials 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
5
Direct Labor Direct Labor
Those 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 Overhead Manufacturing Overhead
Examples: Indirect materials and indirect labor
Wages paid to employees
who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.
Materials used to support
the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.
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Nonmanufacturing Costs Nonmanufacturing Costs
Selling
Costs
Administrative
Costs
Costs necessary to
secure the order and
deliver the product.
All executive,
organizational, and
clerical costs.
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Learning Objective 2 Learning Objective 2
Distinguish between product Distinguish between product
costs and period costs costs and period costs..
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Product Costs Vs Period Cost Product Costs Vs Period Cost
Product costs (assets)
become cost of goods sold after a sale takes place
Product Costs
Period costs are all costs in the income statement
other than cost of goods sold.
Period costs are recorded as expenses of the
accounting period in which they are incurred.
Period Costs
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Product costs
include direct
materials, direct
labor, and
manufacturing
overhead
Period costs include all
selling costs and
administrative costs.
overhead.
Inventory Cost of Good Sold
Balance
Sheet
Income
Statement
Sale
Expense
Income
Statement
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Which of the following costs would be
considered a period rather than a product
cost in a manufacturing company?
A Manufacturing equipment depreciation
Quick Check Quick Check Quick Check Quick Check
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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Comparing Merchandising and
Manufacturing Companies
Comparing Merchandising and
Manufacturing Companies
Merchandisers . . .
Buy finished
goods
Manufacturers . . .
Buy raw materials.
Produce and sell
goods.
Sell finished
goods.
Produce and sell
finished goods.
MegaLoMart
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Revenues xxx
Less:
INCOME STATEMENT
Product Costs
BALANCE SHEET
M h di
Product costs and Period Costs
in a Merchandising Company
Product costs and Period Costs
in a Merchandising Company
Inventory
When sales occur
Merchandise
Purchases
Cost of Goods Sold (xxx)
Gross Margin xxx
Less:
Operating Exp
(Period costs) (XXX)
Operating Income xxx
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Materials
Inventory
Revenues xxx
Less:
INCOME STATEMENT
Product Costs
BALANCE SHEET
Cost of Goods Sold (xxx)
Product costs and Period Costs
in a Manufacturing Company
Product costs and Period Costs
in a Manufacturing Company
Finished Goods
Inventory
When sales occur
Work in Process
Inventory
Gross Margin xxx
Less:
Operating Exp
(Period costs) (XXX)
Operating Income xxx
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Learning Objective 3 Learning Objective 3
Understand the difference between
Variable costs and fixed costs
(Costs Classified by cost behavior) (Costs Classified by cost behavior)
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Cost Classifications for Predicting
Cost Behavior
Cost Classifications for Predicting
Cost Behavior
Cost behavior refers to how a cost will
react to changes in the level of activity.
The most common classifications are:
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Variable costs.
Fixed costs
Mixed costs.
Total
Dollars
Total Variable Cost Total Variable Cost
Variable cost Variable cost
Output
Total Variable Total Variable
Costs (TVC) Costs (TVC)
are costs that
change with
the rate of
output.
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Example: Variable Cost Example: Variable Cost
X Company buys a handlebar at $52 for each of its
bicycles.
What is the total handlebar
cost when 1,000 bicycles
bl d ?
What is the handlebar cost
per bicycle when 1,000
Total Cost
Unit Cost
What is the total
handlebar cost when
3,500 bicycles are
assembled?
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are assembled ?
p y ,
bicycles are assembled ?
What is the handlebar cost
per bicycle when 3,500
bicycles are assembled ?
The Activity Base (Cost Driver) The Activity Base (Cost Driver)
A measure of what
causes the
Units
produced
Machine
hours
incurrence of a
variable cost
Miles
driven
Labor
hours
The number of bicycles assembled is a cost
driver of the cost of handlebars.
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Total
Dollars
Within the relevant
range, Total Fixed Total Fixed
Costs (TFC) Costs (TFC) do not
change with the
rate of output.
Fixed Cost Fixed Cost
Output
Total Fixed Cost Total Fixed Cost
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Total
Dollars
Fixed Cost per unit Fixed Cost per unit
Output
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Types of Fixed Costs Types of Fixed Costs
Discretionary
May be altered in the
short-term by current
Discretionary
May be altered in the
short-term by current
Committed
Long-term, cannot be
significantly reduced in
Committed
Long-term, cannot be
significantly reduced in
Examples
Advertising and
Research and
Development
Examples
Depreciation on Buildings
and Equipment and Real
Estate Taxes
y
managerial decisions
y
managerial decisions
g y
the short term.
g y
the short term.
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R l t
A straight line
closely
approximates a
curvilinear
variable cost line
within the
l t
Economists
Curvilinear Cost
Function
The Linearity Assumption and the
Relevant Range
The Linearity Assumption and the
Relevant Range
Relevant
Range
relevant range.
Activity
T
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C
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Accountants Straight-Line
Approximation (constant unit
variable cost)
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o
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s
a
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d
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o
f

s

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Fixed Costs and the Relevant Range Fixed Costs and the Relevant Range
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Relevant
The relevant range
of activity for a fixed
cost is the range of
R
e
n
t

C
o
s
t

i
n

T
h
o
D
o
l
l
a
r
s
0 1,000 2,000 3,000
Rented Area (Square Feet)
0
30
60
Range
cost is the range of
activity over which
the graph of the
cost is flat.
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X Company incurred $94,500 in a given year
for the leasing of its plant.
Example: Fixed Cost Example: Fixed Cost
What is the total leasing
cost when 1,000 bicycles
bl d?
What is the leasing cost
per bicycle when 1,000
bi l bl d?
Total Cost
Unit Cost
What is the leasing (fixed)
cost 3,500 bicycles are
assembled?
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are assembled? bicycles are assembled?
What is the leasing cost
bicycle when 3,500
bicycles are assembled?
Cost Behavior Summarized Cost Behavior Summarized
Total Costs Cost Per Unit
Variable
costs
Change in proportion
with output
Unchanged in relation to output
More output =More cost
Example
1 000 units =$52 000 1 000 units =$52 1,000 units =$52,000 1,000 units =$52
3,500 units=$182,000 3,500 units=$52
Fixed
Costs
Unchanged in relation to
output
Change inversely with output
More output =lower cost per unit
Example Example
1,000 units =$94,500 1,000 units =$94.50
3,500 units =$94,500 3,500 units=$27.00
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t
Y
A mixed cost contains both variable and fixed
elements. Consider the example of utility cost.
Mixed Costs
(also called semivariable costs)
Mixed Costs
(also called semivariable costs)
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
T
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U
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C
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X
TO BE COVERED IN DETAIL IN WEEK 6.
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Use Unit Costs Cautiously Use Unit Costs Cautiously
Assume that Bicycles management uses a unit cost
of $146.50 (leasing and wheels). Management is
budgeting costs for different levels of production.
What is their budgeted cost for if estimated
production is either 600 bicycles or 3500 bicycles?? p y y
Total fixed cost
Total variable cost
Total
AVG=
If VC + FC = TC
Total fixed cost
Total variable cost
Total
Avg=
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Which of the following costs would be
variable with respect to the number of cones
sold at a Baskins & Robbins shop? (There may
bemorethanonecorrect answer )
Quick Check Quick Check Quick Check Quick Check
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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What is the total fixed cost of the shipping department of EZ-
Mail Clothing Co. if it has the following information for
2009?
Salaries$80000075%of employeesonguaranteedcontracts
Quick Check Quick Check Quick Check Quick Check
Salaries $800,000 75% of employees on guaranteed contracts
Packaging $400,000 depending on size of item(s) shipped
Postage $500,000 depending on weight of item(s) shipped
Rent of warehouse space$250,000 annual lease
A)$850,000
B)$900,000
C)$1,050,000
D)$1,950,000
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Learning Objective 4 Learning Objective 4
Understand the difference
b di d between direct costs and
indirect costs
32
Cost Object Examples at BMW Cost Object Examples at BMW
Cost Object
Illustration
Product BMW X 5sportsactivity vehicle
Cost object is anything for which a separate
measurement of costs is desired.
Cost Object
Product BMW X 5 sports activity vehicle
Service Dealer-support telephonehotline
Project
R&D project on DVD system
enhancement
Customer
Herb Chambers Motors, a dealer
that purchases abroad rangeof
BMW vehicles
Activity Setting up production machines
Department Environmental, Health & Safety
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Cost
Accumulation
Cost
Object 1
Stage Stage
(1)
Cost
Object 2
How to account for costs? How to account for costs?
(2)
Object 2
Cost
Object 3
Cost
Assignment
Through Tracing
& Allocating
34
Assigning Costs to Cost Objects Assigning Costs to Cost Objects
Direct costs
Costs that can be
easily and
conveniently traced to
it f d t
Indirect costs
Costs that cannot be
easily and
conveniently traced to
it f d t a unit of product or
other cost object.
Examples: direct
material and direct
labor
a unit of product or
other cost object.
Example:
manufacturing
overhead, Electricity
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Direct Costs

Example:
Sports
Cost tracing
Example: Paper on which
Sports Illustrated
magazine
is printed
Cost Assignment Cost Assignment
Indirect Costs
Sports
Illustrated
magazine
Cost Allocation
is printed
Example: Lease cost for
the building housing the
senior editors of Sports
illustrated and other
magazines.
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Example: Indirect Costs Example: Indirect Costs
Assume that lease cost for the building housing
the senior editors of Sports illustrated, People
and Time magazines amounts to $900,000 per
annum.
How much is allocated to each magazine ?
[Use the total floor space occupied by the staff of
each magazine as the allocation base. Assume that
each magazine uses same amount of floor space.]
37
Lease
$900,000
Sports
Ill d
Time
Example: Indirect Costs Example: Indirect Costs
People
Illustrated
Magazine
Magazine
38
p
Magazine
Product Cost
Direct costs xxxx
Indirect costs
????? xxxxxx
Lease$300,000
???? xxxxxxx xxxx
xxxx
Product Cost
Direct costs xxxx
Indirect costs
????? xxxxxx
Lease$300,000
???? xxxxxxx xxxx
xxxx
Product Cost
Direct costs xxxx
Indirect costs
????? xxxxxx
Lease$300,000
???? xxxxxxx xxxx
xxxx
Relationships of Types of Costs Relationships of Types of Costs
Direct
Indirect
Variable
Fixed
39

Direct Costs
r
i
a
b
l
e

c
o
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t
Cost Object: FordFocus
Example
Tires usedinassembly of
automobile
Cost Object: FordFocus
Example
Power costs at Detroit plant.
Power usageis meteredonly
to theplant, wheremultiple
Indirect Costs
V
a
r
products areassembled
Cost Object: FordFocus
Example
Salary of supervisor onFord
Focus assembly line
Cost Object: FordFocus
Example
Annual leasecosts at Detroit
plant.
Leaseis for thewholeplant,
wheremultipleproducts are
assembled
F
i
x
e
d

c
o
s
t
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Learning Objective 5 Learning Objective 5
Prepare an income statement Prepare an income statement
including calculation of the including calculation of the
f d ld d f d ld d cost of goods sold and a cost of goods sold and a
schedule of cost of goods schedule of cost of goods
manufactured. manufactured.
41
The Income Statement The Income Statement
Cost of goods sold for manufacturers differs only
slightly fromcost of goods sold for retailers.
Manufacturing Company
Cost of goods sold:
Beg. finished
goods inv. 14,200 $
+ Cost of goods
manufactured 234 150
Retail Company
Cost of goods sol d:
Beg. Fi ni shed
goods i nventory 14,200 $
+ Net Purchases 234,150
manufactured 234,150
Goods available
for sale 248,350 $
- Ending
finished goods
inventory (12,100)
= Cost of goods
sold 236,250 $
,
Goods avai l abl e
for sal e 248,350 $
- Endi ng
i nventory (12,100)
= Cost of goods
sol d 236,250 $
Manufacturing firms must work out the cost of their Finished
Goods Inventory, adding together all the Costs of making the
product. This is the key difference.
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Schedule of Cost of Goods
Manufactured
Schedule of Cost of Goods
Manufactured
Calculates 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.
43
Cost of Goods Manufactured Statement
(Cost of Goods Manufactured is
determined and presented in this
statement)
Manufacturing Company
Cost of goods sold:
Beg. finished
goods inv 14 200 $ goods inv. 14,200 $
+ Cost of goods
manufactured 234,150
Goods available
for sale 248,350 $
- Ending
finished goods
inventory (12,100)
= Cost of goods
sold 236,250 $
44
Directmaterials:
Beginningrawmaterials xxxx
Netpurchases ofrawmaterials xxxx
Costs ofrawmaterials availble xxxx
Less:Endingrawmaterials (xxxx)
Directmaterials used xxxx
Directlabour xxxx
Factoryoverhead:
Indirectlabour xxxx
Supplies xxxx
A ManufacturingEntity
Costof Goods ManufacturedStatement
pp
Electricity xxxx
Rent xxxx
Insurance xxxx
Rates &taxes xxxx
Depreciation xxxx
Miscellaneous xxxx
Total factoryoverhead xxxx
Manufacturingcosts fortheperiod xxxx
Add:Beginningworkinprogress xxxx
Total workinprogress xxxx
Less: Endingworkinprogress xxxx
COSTOFGOODSMANUFACTURED xxxx
45
Flow of Costs
WorkinProcess WorkinProcess
Inventory Inventory
FinishedGoods FinishedGoods
Inventory Inventory
Costof Costof
Goods Sold Goods Sold
Inventory Inventory
RawMaterial Inventory RawMaterial Inventory
Costof Goods Sold Costof Goods Sold
Sale of Finished Goods
Merchandising Merchandising
Manufacturing Manufacturing
Wages Wages
FactoryOverhead FactoryOverhead
46
Selling and
Administrative
Selling and
Administrative
Example: Flow of Costs Example: Flow of Costs
X Company had $50,000 of direct materials
inventory at the beginning of the period.
Purchases during the period amounted to
$180,000 and ending inventory was $30,000. $ 80,000a de d g ve to ywas$30,000.
How much direct materials were used?
47
Direct labor costs incurred were $105,500.
Indirect manufacturing costs were $194,500.
What are the total
Example: Flow of Costs Example: Flow of Costs
manufacturing costs incurred?
Direct materials used
Direct labor
Indirect manufacturing costs
Total manufacturing costs
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Assume that the work in process inventory
at the beginning of the period was $30,000,
and $35,000 at the end of the period.
Example: Flow of Costs Example: Flow of Costs
What is the cost of goods manufactured?
Beginning work in process
Total manufacturing costs
Ending work in process
Cost of goods manufactured
49
Cost of Goods Manufactured Cost of Goods Manufactured
DirectMaterials:
Beginning Inventory, J anuary1 50,000 $
Add: Purchases 180,000
Costof DirectMaterials Available for Use 230,000
Less: Ending Inventory, December 31 30,000
DirectMaterials Used 200,000
DirectLabor 105,500
X Company
Schedule of Costof Goods Manufactured
For the Year Ended December 31, 2008 (inthousands)
Manufacturing Overhead:
IndirectLabor 75,000
Supplies 20,000
Heat, Light& Power 5,000
Depreciation- plantbuilding 50,000
Depreciation- plantequipment 20,000
Miscellaneous 24,500
Total Manufacturing Overhead Costs 194,500
Manufacturing costs incurred during 2008 500,000
Add: Beginning WIP, J anuary1 30,000
Total Manufacturing Costs to accountfor 530,000
Less: Ending WIP, December 31 35,000
Costof Goods Manufactured 495,000 $
50
Assume that the finished goods inventory
at the beginning of the period was $10,000,
and $15,000 at the end of the period.
Example: Flow of Costs Example: Flow of Costs
What is the cost of goods sold?
Beginning finished goods
Cost of goods manufactured
Ending finished goods
Cost of goods sold
51
Income Statement Income Statement
Revenues $700,000
Costof Goods Sold
Beginning Finished Goods, J anuary1 10,000
Costof Goods Manufactured 495,000
Costof Goods Available for sale 505,000
EndingFinishedGoods December 31 15000
X company
Income Statement
For the Year Ended December 31, 2008 (inthousands)
Figure carries
forward from the
Schedule of Cost
of Goods
M f t d
Ending Finished Goods, December 31 15,000
Costof Goods Sold 490,000
Gross Profit 210,000
Operating Costs:
Marketing, distribution, and customer-service 70,000
Total operating costs 70,000
Operating Income $140,000
Manufactured
Period Costs are
expensed as
incurred
52
Classifications of Manufacturing Costs Classifications of Manufacturing Costs
Direct Direct Manufacturing
Manufacturing costs are often
classified as follows:
Material Labor
g
Overhead
Prime
Cost
Conversion
Cost
53
Prime Costs Prime Costs
Direct
Materials
Direct
Labor
Prime
Costs
+ =
What are the prime costs for X Company?
Direct materials used
+Direct labor
=
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Conversion Costs Conversion Costs
Direct
Labor
Manufacturing
Overhead
+ =
Conversion
Costs
Indirect
Labor
Indirect
Materials
Other
What are the conversion costs for X Company?
Direct labor $105,500
+Indirect manufacturing costs 194,500
= $300,000
55
Measuring Costs Requires J udgment Measuring Costs Requires J udgment
Direct
manufacturing
labour
Manufacturing
overhead
Labour cost
Indirect
labour
Manager's
salaries
Fringe
costs
56
Learning Objective 6 Learning Objective 6
Define cost classifications used Define cost classifications used
in making decisions: in making decisions:
differential costs, opportunity differential costs, opportunity
costs, and sunk costs. costs, and sunk costs.
57
Every decision involves a choice between at least
two alternatives.
Onlythosecostsandbenefitsthat differ between
Cost Classifications for Decision
Making
Cost Classifications for Decision
Making
Only those costs and benefits that differ between
alternatives are relevant in a decision. All other
costs and benefits can and should be ignored.
58
Differential Cost and Revenue Differential Cost and Revenue
Costs and revenues that
differ among alternatives
Example: You have a job paying $1,500 per month in
differ among alternatives.
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 = $500
Differential cost is:
$300
59
Opportunity Cost Opportunity Cost
The potential benefit that is
given up when one
alternative is selected over
another.
Example: p
If you were not attending university, you
could be earning $40,000 per year.
Your opportunity cost of attending college for
one year is $40,000.
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Sunk Costs Sunk Costs
Sunk costs have already been incurred
and cannot be changed now or in the
future. These costs 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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Distribution
Customer
Service
Elimination of non-val ue-
added activities
Costs by business functions
Value chain is sequence of business functions in which usefulness is
added to the products or services of an organization.
Research and
Development
Design
Production
Marketing
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Different Definitions of Cost for
Different Applications
Different Definitions of Cost for
Different Applications
Pricing and product-mix decisions may
use a super cost approach
(comprehensive)
Contracting with government agencies
ifi d fi iti f t f t very specific definitions of cost for cost
plus profit contracts
Preparing external-use financial statements
GAAP-driven product costs only
63
R & D Design Production Marketing Distribution Service
External Reporting?
Product costs for Pricing and Product-Mix decisions?
Product costs for Reimbursement?
64
Summary of the Types of Cost
Classifications
Summary of the Types of Cost
Classifications
Financial
Reporting
Predicting Cost
Behavior
Assigning Costs to
Cost Objects
Making Business
Decisions
66
Research and development costs
Design costs
Production costs
Marketing costs
Distribution costs
C t i t
Direct costs
Indirect costs
Total Cost
Average cost
Customer service costs
Fixed costs
Variable costs
Mixed costs
Product Costs
Period costs
Prime cost
conversion cost
Differential cost
Sunk cost
Opportunity cost
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