BA 115 Chapter 1

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Managerial Accounting and

Cost Concepts
Chapter 1
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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Outline
I. Management Accounting
A. Definition
B. Difference with Financial Accounting
C. Value for Managers
II. Costs, Costs, Costs

A. Different Costs for Different Purposes
B. Cost Classifications
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Management Needs Financial

Accounting and Managerial Accounting
 Financial accounting is concerned with reporting
financial information to external parties, such as
stockholders, creditors, and regulators.
 Managerial accounting is concerned with providing
information to managers within an organization so
that they can formulate plans, control operations,
and make decisions.
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More than One Definition of Cost

A Tale of Two Trucks
Brand Isuzu Hyundai
Purchase Price 4,500,000 4,750,000
Year Purchased 2012 2018
Useful Life 15 15
Residual Value 450,000 475,000
Straight Line
Depreciation/Year 270,000 285,000
Book Value, 1.1.20 2,340,000 4,180,000
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Financial and Managerial

Accounting: Seven Key Differences
Financial Accounting Managerial Accounting
External persons who make financial Managers who plan for and control an
1. Users
decisions organization
2. Time focus Historical perspective Future emphasis
3. Verifiability versus Emphasis on objectivity and

Emphasis on relevance
relevance verifiability
4. Precision versus
Emphasis on precision Emphasis on timeliness
timeliness
Primary focus is on companywide
5. Subject Focus on segment reports
reports
Must follow GAAP/IFRS and prescribed Not bound by GAAP/IFRS or any

6. Rules
formats prescribed format
7. Requirement Mandatory for external reports Not Mandatory
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Management Accounting Supports

the Work of Management
 Planning – process of specifying courses of action or
steps to take in order to achieve an objective
◦ How much should we budget for TV, print, and Internet advertising?
◦ How many salespeople should we plan to hire to serve a new territory?
 Controlling – process of checking against a standard

or expectation
◦ Is the budgeted price cut increasing unit sales as expected?
◦ Are we accumulating too much inventory during the holiday shopping
season?
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Management Accounting Supports

the Work of Management
 Decision Making – analysis of alternatives to
determine a feasible or desired course of action
◦ Should we sell our services as one bundle or sell them separately?
◦ Should we sell directly to customers or use a distributor?
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Ch 1 Theme:
How do I cost thee?
Let me count the ways.
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Purposes of Cost Classification

1. Costs for Financial Accounting Purposes
a. Manufacturing and non-manufacturing costs
b. Product costs and period costs
2. Costs for Management Accounting Purposes

a. Traceability to cost objects (direct, indirect, common)
b. Behavior (variable, fixed, mixed)
c. Decision-making (differential, sunk, opportunity)
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Manufacturing Costs
1. Direct Materials
2. Direct Labor
3. Manufacturing Overhead
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Direct Materials
 Direct materials are raw materials that become an

integral part of the product and that can be
conveniently traced directly to it.
 Example: Flour and Sugar in a batch of
Ensaymada
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Direct Labor
 Direct labor consists of labor costs that can be

easily traced to individual units of product.
 Example: Wages of bakers of the ensaymada
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Manufacturing Overhead
 Manufacturing overhead includes all

manufacturing costs except direct material and
direct labor. These costs cannot be readily traced
to finished products.
◦ Includes indirect materials that cannot be easily or
conveniently traced to specific units of product
◦ Includes indirect labor that cannot be easily or
conveniently traced to specific units of product
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Manufacturing Overhead – Examples
 Examples of manufacturing overhead:

◦ Depreciation of baking equipment
◦ Utility costs
◦ Property taxes
◦ Insurance premiums incurred to operate a baking
facility
 Only those indirect costs associated with
operating the baking facility are included in
manufacturing overhead.
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Prime Costs and Conversion Costs
Manufacturing costs are often classified as

follows:
 Prime cost
◦ Direct materials
◦ Direct labor
 Conversion cost
◦ Direct labor
◦ Manufacturing overhead
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Nonmanufacturing Costs
 Selling costs
◦ The costs incurred to secure customer orders and
get the finished product to the customer. Selling
costs can be either direct or indirect costs.
 Administrative costs
◦ The costs associated with the general management
of an organization rather than with manufacturing
or selling. Administrative costs can be either direct
or indirect costs.
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Product Costs
 Product costs include all the costs involved in

acquiring or making a product.
 Product costs “attach” to a unit of product as it is
purchased or manufactured and they stay
attached to each unit of product as long as it
remains in inventory awaiting sale.
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Manufacturing Product Costs
For manufacturing companies, product costs

include:
 Raw materials include any materials that go into
the final product.
 Work in process consists of units of product that
are only partially complete and will require
further work before they are ready for sale to the
customer.
 Finished goods consist of completed units of
product that have not yet been sold to customers.
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Transfer of Product Costs
 When direct materials are used in production, their

costs are transferred from Raw Materials to Work in
Process.
 Direct labor and manufacturing overhead costs are
added to Work in Process to convert direct materials
into finished goods.
 Once units of product are completed, their costs are
transferred from Work in Process to Finished Goods.
 When a manufacturer sells its finished goods to
customers, the costs are transferred from Finished
Goods to Cost of Goods Sold.
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Cost Classifications for Preparing

Financial Statements (1 of 2)
Product costs include direct materials, direct labor, and
manufacturing overhead.
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Cost Classifications for Preparing

Financial Statements (2 of 2)
Period costs include all selling costs and
administrative costs.
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Concept Check 1
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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Concept Check 1a
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
Answer: B, E
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Assigning Costs to Cost Objects

 Direct costs
◦ Costs that can be easily and conveniently traced to a
unit of product or other cost object.
◦ Examples: direct materials and direct labor
 Indirect costs
◦ Costs that cannot be easily and conveniently traced
to a unit of product or other cost object.
◦ Example: manufacturing overhead
 Common costs
◦ Indirect costs incurred to support a number of cost
objects. These costs cannot be traced to any
individual cost object.
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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:
◦ Variable costs.
◦ Fixed costs.
◦ Mixed costs.
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Variable Cost
 A variable cost varies, in total, in direct proportion to
changes in the level of activity.
 A variable cost per unit is constant.
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An Activity Base (Cost Driver)

 An activity base is a measure of what causes the
incurrence of a variable cost.
◦ Units produced
◦ Machine hours
◦ Miles driven
◦ Labor hours
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Fixed Cost
 A fixed cost is a cost that remains constant, in total,
regardless of changes in the level of the activity.
 If expressed on a per unit basis, the average fixed cost
per unit varies inversely with changes in activity.
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Types of Fixed Costs

 Committed
◦ Long term, cannot be significantly reduced in the
short term
 Discretionary
◦ May be altered in the short term by current
managerial decisions
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The Linearity Assumption and the

Relevant Range
 The relevant range of activity pertains to fixed cost as
well as variable costs. For example, assume office
space is available at a rental rate of $30,000 per year
in increments of 1,000 square feet.
 Fixed costs would increase in a step fashion at a rate
of $30,000 for each additional 1,000 square feet.
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Relevant Range: Graphic
The relevant range of activity for a fixed cost is the range

of activity over which the graph of the cost is flat.
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Comparison of Cost Classifications

for Predicting Cost Behavior
Behavior of Cost (within the relevant range)

Cost In Total Per Unit
Total variable cost increases and decreases in Variable cost per unit remains
Variable cost
proportion to changes in the activity level. constant.
Fixed cost per unit decreases as

Total fixed cost is not affected by changes in the activity level rises and
Fixed cost
the activity level within the relevant range. increases as the activity level
falls.
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Concept Check 2
Which of the following costs would be variable with respect
to the number of ice cream cones sold at a BTIC stall? (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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Concept Check 2a
Which of the following costs would be variable with respect
to the number of ice cream cones sold at a BTIC stall? (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
Answer: C, D
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Mixed Costs (1 of 2)
A mixed cost contains both variable and fixed elements.
Consider the example of utility cost.
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Mixed Costs (2 of 2)
The total mixed cost line can be expressed as an
equation: Y = a + bX
Where:
Y = The total mixed cost
a = The total fixed cost (the vertical intercept
of the line)
b = The variable cost per unit of activity (the
slope of the line)
X = The level of activity
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Mixed Costs – An Example

If your fixed monthly utility charge is $40, your variable
cost is $0.03 per kilowatt hour, and your monthly
activity level is 2,000 kilowatt hours, what is the amount
of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
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Cost Classifications for

Decision Making
 Decisions involve choosing between alternatives. The
goal of making decisions is to identify those costs that
are either relevant or irrelevant to the decision.
 It is important to understand the terms differential
cost and revenue, sunk cost, and opportunity cost.
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Differential Costs
 Differential cost (or incremental cost) is the
difference in cost between any two alternatives.
 A difference in revenue between two alternatives is
called differential revenue.
 Both are always relevant to decisions.
 Differential costs can be either fixed or variable.
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Sunk Costs
 Sunk costs have already been incurred and cannot be
changed by any decision made now or in the future.
 These costs should be ignored when making
decisions.
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Opportunity Cost
 Opportunity cost is the potential benefit that is given
up when one alternative is selected over another.
 These costs are not usually found in accounting
records but must be explicitly considered in every
decision.
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Concept Check 3
Suppose you are trying to decide whether to drive or take
the MRT to Taguig to attend a concert. You have ample cash
to do either, but you don’t 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 Taguig?
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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Concept Check 3a
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 don’t 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.
Answer: A
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The Traditional and

Contribution Formats
Traditional Format Contribution Format
Sales $ 100,000 Sales $ 100,000
Cost of goods sold 70,000 Variable expenses 60,000
Gross margin $ 30,000 Contribution margin $ 40,000
Selling & admin. expense 20,000 Fixed expenses 30,000
Net operating income $ 10,000 Net operating income $ 10,000
Traditional format  Used primarily for

external reporting
Contribution format  Used primarily by
management

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1-2

Managerial Accounting and

II. Costs, Costs, Costs

Management Needs Financial

More than One Definition of Cost

Financial and Managerial

2. Time focus Historical perspective Future emphasis

3. Verifiability versus Emphasis on objectivity and

Must follow GAAP/IFRS and prescribed Not bound by GAAP/IFRS or any

7. Requirement Mandatory for external reports Not Mandatory

Management Accounting Supports

 Controlling – process of checking against a standard

Management Accounting Supports

Purposes of Cost Classification

2. Costs for Management Accounting Purposes

 Direct materials are raw materials that become an

 Direct labor consists of labor costs that can be

 Manufacturing overhead includes all

Manufacturing Overhead – Examples

 Examples of manufacturing overhead:

Prime Costs and Conversion Costs

Manufacturing costs are often classified as

 Product costs include all the costs involved in

Manufacturing Product Costs

For manufacturing companies, product costs

Transfer of Product Costs

 When direct materials are used in production, their

Cost Classifications for Preparing

Cost Classifications for Preparing

Which of the following costs would be considered a

Which of the following costs would be considered a

Assigning Costs to Cost Objects

Cost Classifications for Predicting

An Activity Base (Cost Driver)

Types of Fixed Costs

The Linearity Assumption and the

Relevant Range: Graphic

The relevant range of activity for a fixed cost is the range

Comparison of Cost Classifications

Behavior of Cost (within the relevant range)

Fixed cost per unit decreases as

Mixed Costs – An Example

Cost Classifications for

The Traditional and

Traditional format  Used primarily for

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