Introduction

to Cost and
Management
Accounting

P G D M 2 0 21 - 2 3

R E L E VA N T R E A D I N G S –
CHAPTERS 1, 5 AND 6
 Introduction to Managerial Accounting

Informational need of management

Session Interface between Financial, Cost and Managerial

Coverage Accounting

Costing terminology and cost flows

Understanding cost behavior

Managerial Accounting
Managerial accounting is designed for internal users
The goal of Managerial Accounting is to provide the information managers
need for
◦ Planning
◦ Control
◦ Decision making
Managerial vs Financial
Accounting
Unlike Financial Accounting, Managerial Accounting:
◦ Is directed at internal users
◦ May deviate from GAAP
◦ Presents more detailed information
◦ May present more nonmonetary information
◦ Places more emphasis on the future
Accounting Information Systems
– Contemporary View

TRADITIONAL NONFINANCIAL
FINANCIAL Accounting Information
Information

Qualitative
Financial Other Quantitative Information:
Information:
Information: • Percentage of Defects
•Customer &
• Assets Employee
• # Customer Complaints
• Liabilities Satisfaction
• Warranty Claims
• Revenues •Product &
• Inventory Units
Service Quality
• Gross Margin • Budgeted Hours
•Reputation
• Operating
Expenses
https://www.investopedia.com/terms/m/managerialaccounting.asp
The Information Needs of
Internal Users
Marketing, operations and
User production, finance, and human
resource managers

Accounting Timely, detailed information on sales

Information and expenses, product costs, budget
Needed data, and measures of performance.

Source Cost reports, budgets, and other

internal documents.
Decision-Making
The process of identifying different courses of
action and selecting one appropriate to a given
situation.

An effective decision making model is one that

focuses on relevant factors that differ between
alternatives.
 Relevant Sunk Opportunity
Costs Costs Costs
These are avoidable or can
These are costs that have already These are benefits forgone by
be eliminated by choosing
been incurred. They cannot be choosing one alternative over
one alternative over
avoided and are irrelevant. another. They are relevant.
another.

Example: Watching a horrible Example: Choosing to go to

Example: Buying a car with
rental movie that is unbearable college or work full-time. The
a Apple play system versus
during its first 20 minutes. The opportunity cost is the higher
buying a car without one.
rental fee is a sunk cost. You can salary you will receive as a
either decide to stick it out or use college graduate. (In general,
the time to do something more these costs are hard to quantify.)
fun.
Ethics and Decision Making
In today’s business environment, companies have to be
aware not only of the economic impact of their decisions,
but also of their ethical impact.

Information
Good Ends?
being used Bad Ends?
for?
Product costing
Introduction
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For Financial To Determine
Statement The process of Sales Price
Purposes
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determining ???
product or
service costs
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can be quite ???
To complicated. For Income
Project Tax Forms
Profits ???
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 Types of
Companies
Manufacturing:
Take raw materials and produce new
products from them.
Merchandising:
Retail and wholesale merchandising
companies sell products that someone
else has manufactured.
Service:
Provide a service such as airlines,
hospitals, repair shops, law firms, CPA
firms.
 Manufacturing Manufacturing Costs
Versus
• Costs incurred in the factory or plant
Nonmanufacturing
Costs Nonmanufacturing
Costs
• Costs that are incurred outside the
plant or factory and typically
categorized as selling and
administrative costs.
 Manufacturing
Costs Direct Materials Direct Labor Manufacturing
Overhead
Cost of materials directly Cost of labor directly Cost of manufacturing
traceable to items traceable to items activities other than direct
Direct Costs – Conveniently traceable produced produced materials and direct labor
Indirect Costs – Not Conveniently traceable Materials not directly
traceable are indirect
Labor costs not directly
traceable are indirect
materials labor

Direct Direct Manufacturing

Materials Labor Overhead
Example: Wages paid to automobile assembly workers
Example: A radio installed in an automobile

Examples: Indirect materials and indirect labor

Lubricants and cleaning supplies used

in the automobile assembly plant.

Maintenance workers, janitors and

The Product security guards.
Common
Manufacturing
Overhead
Costs
Non-manufacturing Costs
Nonmanufacturing costs (also known as period costs) are all costs that are
not associated with the production of goods. They are expensed in the Profit
and Loss Account.
◦ Selling Costs
◦ Costs associated with securing and filling customer orders e.g.
advertising, sales salaries, depreciation of sales equipment.
◦ General and Administrative Costs
◦ Costs associated with the firm’s general management e.g. Human
resources, accounting, corporate headquarters and other support costs.
Product Product Costs
◦ Costs assigned to goods produced (i.e. direct materials, direct labor,
and manufacturing overhead)
and Period ◦ Included in inventory until goods sold
Period Costs
Costs ◦ Costs identified with accounting periods (i.e selling and administrative
expenses)
◦ Expensed in period incurred
 Manufacturing Cost Flows
Balance Sheet Costs Income
Material Purchases Raw Materials Statement
Expenses

Direct Labor Work in

Process
Manufacturing
Overhead Finished Cost of
Goods Goods
Inventories
Sold

Selling and Period Costs Selling and

Administrative Administrative
Product Costs and Period Costs
Direct Materials
As
Products
Are SOLD
Direct Labor As
Products
Are Balance Sheet Income
Produced Inventories Statement
Manufacturing
Overhead

Period Costs
Direct Versus Indirect Costs

Direct Costs –
Conveniently Traceable

Indirect Costs - Not

Conveniently Traceable
A Schedule of Cost of Goods Manufactured
NORTHERN LIGHTS CUSTOM CABINETS
SCHEDULE OF COST OF GOODS MANUFACTURED
FOR THE YEAR ENDED DECEMBER 31, 2010
Beginning Raw Materials Rs.500,000
Add: Raw Materials purchased 2,000,000
Raw Materials Available 2,500,000
Deduct: Ending Raw Materials 250,000
Raw Materials Used in Production Rs.2,250,000
Direct Labor 3,250,000
Manufacturing Overhead 4,250,000
Total Manufacturing Costs 9,750,000
Add: Beginning Work-In-Process 750,000
10,500,000
Deduct: Ending Work-In Process 1,000,000
Cost of Goods Manufactured Rs.9,500,000
Schedule of Cost of Goods Sold
NORTHERN LIGHTS CUSTOM CABINETS
SCHEDULE OF COST OF GOODS SOLD
FOR THE YEAR ENDED DECEMBER 31, 2010
Beginning Finished Goods Inventory Rs.1,500,000
Add: Cost of Goods Manufactured 9,500,000
Goods Available for Sale 11,000,000
Deduct: Ending Finished Goods Inventory 250,000
Cost of Goods Sold 10,750,000
The Income Statement
NORTHERN LIGHTS CUSTOM CABINETS
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2010
Sales Rs.25,000,000
Cost of Goods Sold:
Beginning Finished Goods Inventory Rs.1,500,000
Add: Cost of Goods Manufactured 9,500,000
Goods Available for Sale 11,000,000
Deduct: Ending Finished Goods Inventory 250,000 10,750,000
Gross Margin 14,250,000
Less: Selling and Administrative Expense 8,750,000
Net Operating Income 5,500,000
Cost Behavior and
Relevant Costs
CHAPTER 6
 Fixed versus Variable Costs

Variable Costs
◦ Change in proportion to changes in
volume or activity

Fixed Costs
◦ Do not change in response to changes
in volume or activity
Relevant Range
The relevant range is the normal range of
production that can be expected for a
particular product and company.

The relevant range can also be viewed as

the volume of production for which the
fixed and variable cost relationships hold
true.

The concept of the relevant range allows managerial

accountants to assume a linear cost relationship.
Step Costs
▪ Some costs vary but only with relatively
large changes in production volume.
Costs like these are sometimes referred
to as step costs.
▪ Although step costs are technically not
fixed costs, they may be treated as such
if they remain constant within a relatively
wide range of production.
Example:
Lets take an example of janitorial services within a
company. As long as production is below 7,500 desks,
the company will hire one janitor with salary and fringe
benefits totaling Rs.1,250,000. But if desk production
exceeds 7,500, the company would hire a second janitor
at a cost of another Rs.1,250,000.
 A Comparison of Absorption
Costing and Variable Costing
Absorption Costing

*Product costs attach to the product.

* They are expensed when the product is sold.

* Used for both external financial statements

prepared under GAAP and for income tax reporting.

Variable Costing
When units produced exceed units sold, absorption costing will report higher net
* Only variable costs are product costs.
income than variable costing.
* Fixed manufacturing overhead is a period cost.
When units sold exceed units produced, variable costing will report higher net income
* Used for internal decision making. than will absorption costing.

When units sold equal units produced, variable costing will report the same net
income than will absorption costing.
Problems with Absorption Costing
The use of absorption costing for internal decision making can result in less than-optimal
decisions.

For Example: By increasing production, unethical managers can increase income, reduce cost of
goods sold, meet their own bonus goals, and saddle the company with the costs of unsold
inventory and storing/insurance costs.
Choosing the Best Method for
Performance Evaluation
For external reporting and income tax filing, managers have no choice but to use absorption
costing, as it is required by GAAP.

However, using variable costing for internal decision making removes the impact of changing
production levels on income and is best for performance evaluation of managers.
Advantages of Variable Costing
Changes in
Variable costing focuses
production and
attention on relevant product
inventory levels
costs rather than on fixed
do not impactproduct 1
the costs, which are
calculation of often unavoidable.
Under variable costing,
cost behavior is
profits. emphasized, and fixed
costs are

Variable costing 3 separated from variable

costs on the income
statement.
2
is consistent with
the use of 4
variance analysis.
Variable costing
income is more closely

5 aligned with a
company’s cash flows.
1. (LO1—Inventory accounts—raw materials, WIP, and finished goods) Raw materials inventory is the inventory of
materials needed for the manufacturing process but not yet put into production. Work-in-process inventory is the
inventory of unfinished (partially finished) products. Finished goods inventory is the inventory of goods that have been
completed and are waiting to be sold.

2. (LO1 and 2—Comparison of traditional manufacturing environment and JIT) JIT systems are called pull systems because
they start with the customer order and products are pulled through the manufacturing process. In contrast, traditional
systems are called push systems because raw materials, work in process and finished goods are pushed through the
manufacturing process regardless of whether a customer has been identified for the finished product.

3. (LO2—Description of JIT system) A JIT system is one in which a customer order starts the manufacturing process and raw
materials are purchased just in time to be used in production and goods are completed just in time to be shipped to
customers.

4. (LO2—JIT and lean production benefits) Advantages of JIT and lean production manufacturing are likely to include:

1. A reduction in waste and scrap

2. Improving the quality of products

3. Lower overall production costs (although the costs of raw materials may increase in some cases)

4. Lower labor costs

5. Inventory reduction

6. Reduced processing time

7. Increased manufacturing flexibility

5. (LO2—Applying Lean production to a service company) A bank might apply lean production techniques in an effort to
reduce the time that customers wait in line to make deposits or conduct other business with a bank teller. This might
include changing the process for counting money and checks, and reconfiguring the work space so that tellers and other
bank personnel can work more efficiently. Banks might also apply lean production techniques in an effort to reduce the
amount of time it takes for customers to complete loan applications and for loans to be approved. This might include
allowing customers to complete application forms online and streamlining the approval process to reduce the time from
application to approval.

6. (LO 3—Direct vs. indirect costs) Direct costs such as direct materials and direct labor can be directly and conveniently
traced to a particular product or cost object and become an integral part of the finished product. Indirect costs like indirect
materials and indirect labor, while required in the manufacture of a product or provision of a service cannot be
conveniently and easily traced to the product or cost object.

7. (LO 3—Manufacturing costs) The three components of manufacturing costs are direct materials, direct labor, and
manufacturing overhead. Manufacturing overhead includes indirect materials used in the manufacturing process, indirect
labor, and other costs associated with manufacturing a product, including but not limited to repairs and maintenance,
supplies, utilities, rent, and items like insurance, taxes, and depreciation on the manufacturing plant and equipment.

8. (LO 3—Nonmanufacturing costs) Nonmanufacturing costs include all costs incurred outside the factory and are
categorized as selling and administrative costs. Nonmanufacturing costs are also called period costs. Students should note
that the same types of costs classified as manufacturing costs can be classified as nonmanufacturing costs. For example,
repairs and maintenance, supplies, utilities, rent, insurance, taxes and depreciation incurred outside the factory or plant
would be classified as nonmanufacturing costs.

9. (LO 4—Cost flows in a manufacturing environment) Manufacturing costs (i.e., direct materials, direct labor, and
manufacturing overhead) are combined in the production process in such a way as to become work-in-process inventory.
After the production process is completed the work-inprocess inventory is transformed into finished goods inventory and is
available to be sold to customers. Upon sale, the cost of finished goods inventory becomes part of the cost of goods sold
for the period.

10. (LO 5—Cost vs. expense) Although often used interchangeably, cost and expense are not synonymous terms. Costs can
be classified in a number of ways including manufacturing (product costs) or nonmanufacturing (period costs). Costs are
incurred anytime resources are used up in providing goods and services. For example, direct material and direct labor costs
are incurred when cash is spent to purchase materials or hire workers. On the other hand, expenses can be thought of as
expired or used up costs. As you will recall, product costs are only expensed (as cost of goods sold) when the product is
sold. On the other hand, period costs are expensed in the period in which they are incurred.

11. (LO 5—Product vs. period costs) Manufacturing costs are called product costs because they attach to the product and
are only expensed when the product is sold. Nonmanufacturing costs are called period costs because they are expensed in
the period in which they are incurred.

12. (LO 5—The need for product costing) Companies need to determine accurate product costs in order to determine if
products should be produced and if so, what price should be charged for those products. Costing information is also used
to help determine how much of a product to make and in forecasting cash disbursements.

1. (LO 1—Cost behavior of direct material) Direct materials are a variable cost and increase (decrease) in total as
production increases (decreases), while remaining constant when expressed on a per unit basis.

2. (LO 1—Cost behavior and the relevant range) The relevant range of production is the normal range over which
production varies. Within this range, fixed and variable cost relationships will hold true.

3. (LO 1—Cost behavior of fixed costs) When volume increases, fixed costs per unit will decrease. Likewise, when volume
decreases, the unit cost will increase. This is called an inverse or reciprocal relationship.

4. (LO 1—Equation for mixed costs) TC = FC + VC(x); where x = the volume of activity

5. (LO 2—Regression analysis) When used to estimate the fixed and variable components of a mixed cost, the dependent
variable in regression analysis is the total cost (represented by y in the equation y = a + bx. The independent variable is the
activity level or production level (represented by x in the equation y = a + bx).

6. (LO 2—Regression analysis) R2 is a measure of the goodness of fit or how well the regression line approximates actual
costs. A value of 1.0 means perfect correlation between the dependent and independent variables.

7. (LO 2—High/low method) If the high or low activity level is unusual (an outlier), the cost estimate provided by the high-
low method is likely to be inaccurate.

8. (LO 3—Relevant costs and decision making) In the short run, fixed costs are constant, are not avoidable, and do not
differ under different alternatives.

9. (LO 3—Relevant costs and decision making) Irrelevant costs relate to the past or do not differ under different
alternatives in the present, while relevant costs are avoidable or can be eliminated by choosing one alternative over
another. Relevant costs must be considered in making decisions, while irrelevant costs should not be considered.

10. (LO 4—Impact of taxes on costs) Many costs that are incurred by businesses are tax deductible, effectively reducing the
out-of-pocket cost of the item.

11. (LO 1—Absorption vs. variable costing) If production exceeds sales, absorption costing will always show higher net
income because the product cost includes fixed manufacturing overhead. When product is not sold, the cost remains on
the balance sheet and does not impact net income.

12. (LO 1—Absorption vs. variable costing) If sales exceed production, variable costing will show higher net income.
Absorption costing, which has a higher cost per unit, will move more costs to the income statement than will variable
costing which expenses fixed costs each period.

13. (LO 1—Absorption vs. variable costing) When production equals sales, variable costing and absorption costing will show
the same amount of net income.

14. (LO 1—Absorption vs. variable costing) The basic difference between absorption and variable costing is the treatment
of fixed manufacturing overhead. Absorption costing treats fixed overhead as a product cost while variable costing treats
fixed overhead as a period cost.

15. (LO 2—Income statement impact of absorption costing) Under absorption costing, net income can be increased by
increasing production. While total fixed manufacturing overhead costs will remain the same when production increases,
the cost per unit will be reduced. Consequently, the cost of goods sold will be reduced.
16. (LO 2—Income statement impact of absorption costing) Fixed costs are part of product costs under absorption costing
so are included as inventory in the items are unsold and move to the income statement only when the product is sold.

17. (LO2—Income statement impact of absorption costing) Under absorption costing, net income can be increased by
increasing production. While total fixed manufacturing overhead costs will remain the same when production increases,
the cost per unit will be reduced. Consequently, the cost of goods sold will be reduced.

18. (LO 2—Income statement impact of absorption costing) Selling and administrative costs are always expensed in each
period but are shown separately on the income statement as variable or fixed.