1-1

Managerial Accounting and

Cost Concepts
Chapter 1

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
April L. Mohr, MAcc, CPA
 1-2

Needs of Management
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.
 1-3

Purposes of Cost Classification

1. Assigning costs to cost objects
2. Accounting for costs in manufacturing
companies
3. Preparing financial statements
4. Predicting cost behavior in response to
changes in activity
5. Making decisions
 1-4

Learning Objective 1

Understand cost classifications

used for assigning costs to cost
objects: direct costs and
indirect costs.
 1-5

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
material 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.
 1-6

Learning Objective 2

Identify and give examples

of each of the three basic
manufacturing cost
categories.
 1-7

Classifications of Manufacturing Costs

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product
 1-8

Direct Materials
Raw materials that become an integral
part of the product and that can be
conveniently traced directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile
 1-9

Direct Labor

Those labor costs that can be easily

traced to individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers
 1-10

Manufacturing Overhead
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
 1-11

Manufacturing Overhead – Examples

 Examples of manufacturing overhead:
◦ Depreciation of manufacturing equipment
◦ Utility costs
◦ Property taxes
◦ Insurance premiums incurred to operate a
manufacturing facility
 Onlythose indirect costs associated with
operating the factory are included in
manufacturing overhead.
 1-12

Prime Costs and Conversion Costs

Manufacturing costs are often

classified as follows:
 Prime cost
◦ Direct materials
◦ Direct labor
 Conversion cost
◦ Direct labor
◦ Manufacturing overhead

Nonmanufacturing Costs
Selling
Costs
The costs incurred to secure
customer orders and get the
finished product to the
customer. Selling costs can
either be direct or indirect
costs.
1-13
Administrative
Costs
The costs associated with the
general management of an
organization rather than with
the manufacturing or selling.
Administrative costs can be
either direct or indirect costs.
 1-14

Learning Objective 3

Understand cost
classifications used to
prepare financial
statements: product costs
and period costs.
 1-15

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.
 1-16

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.
 1-17

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.
 1-18

Cost Classifications for Preparing

Financial Statements (1 of 2)
Product costs include direct materials, direct labor,
and manufacturing overhead.
 1-19

Cost Classifications for Preparing

Financial Statements (2 of 2)
Period costs include all selling costs and
administrative costs.
 1-20

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.
 1-21

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.
 1-22

Learning Objective 4

Understand cost
classifications used to
predict cost behavior:
variable costs, fixed costs,
and mixed costs.
 1-23

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.
 1-24

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.
 1-25

The Activity Base (Cost Driver)

Units Machine
produced hours

A measure of what
causes the
incurrence of a
variable cost

Miles Labor
driven hours
 1-26

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.
 1-27

Types of Fixed Costs

Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced in short term by current
the short term. managerial decisions
 1-28

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.
 1-29

Relevant Range: Graphic

90
Rent Cost in Thousands

The
The relevant
relevant range
range
Relevant of
of activity
activity for
for aa fixed
fixed
60
of Dollars

cost
cost is
is the
the range
range of of
Range activity
activity over
over which
which
the
the graph
graph ofof the
the
cost
cost is
is flat.
flat.
30

0
0 1,000 2,000 3,000
Rented Area (Square Feet)
 1-30

Cost Classifications for Predicting Cost

Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost Increase Variable cost per unit

and decrease in proportion remains constant.
to changes in the activity level.
Fixed Total fixed cost is not affected Fixed cost per unit decreases
by changes in the activity as the activity level rises and
level within the relevant range. increases as the activity level falls.
 1-31

Concept Check 2

Which of the following costs would be

variable with respect to the number of ice
cream cones sold at a Baskin & Robbins?
(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.
 1-32

Concept Check 2a

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.
 1-33

Mixed Costs (1 of 2)
A
A mixed
mixed cost
cost contains
contains both
both variable
variable and
and fixed
fixed
elements.
elements. Consider
Consider the
the example
example of
of utility
utility cost.
cost.
Y
Total Utility Cost

ost
d c
x e
al mi
To t
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 1-34

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.
 1-35

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
 1-36

Learning Objective 5

Understand cost
classifications used in
making decisions:
differential costs, sunk
costs, and opportunity
costs.
 1-37

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.
 1-38

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.
 1-39

Sunk Costs

Sunk costs have already been incurred and

cannot be changed by any decision now or in the
future.
These costs should be ignored when making
decisions.
 1-40

Opportunity Cost
The potential benefit that is given
up when one alternative is
selected over another.

These
These costs
costs are
are not
not usually
usually found
found in
in accounting
accounting
but
but must
must be
be explicitly
explicitly considered
considered in
in every
every
decision.
decision.

For
For students:
students: What
What are
are the
the opportunity
opportunity costs
costs you
you incur
incur
to
to attend
attend this
this class?
class?
 1-41

Concept Check 3

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.
 1-42

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.
 1-43

Concept Check 4

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 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.
 1-44

Concept Check 4a

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 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.
 1-45

Concept Check 5

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.
 1-46

Concept Check 5a

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.
 1-47

Learning Objective 6

Prepare income statements

for a merchandising
company using the
traditional and
contribution formats.
 1-48

The Traditional and Contribution Formats

Comparison of the Contribution Income Statement

with the Traditional Income Statement

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. expenses 20,000 Fixed expenses 30,000
Net operating income $ 10,000 Net operating income $ 10,000

Used primarily for Used primarily by

external reporting. management.
 1-49

Uses of the Contribution Format

The
The contribution
contribution format
format income
income statement
statement is
is used
used
as
as an
an internal
internal planning
planning and
and decision-making
decision-making tool.
tool.
We
We will
will use
use this
this approach
approach for:
for:
1.Cost-volume-profit
1.Cost-volume-profit analysis
analysis (Chapter
(Chapter 6).
6).
2.Segmented
2.Segmented reporting
reporting of
of profit
profit data
data (Chapter
(Chapter 7).
7).
3.Budgeting
3.Budgeting (Chapter
(Chapter 8).
8).
4.Special
4.Special decisions
decisions such
such as
as pricing
pricing and
and make-or-
make-or-
buy
buy analysis
analysis (Chapter
(Chapter 11).
11).
 1-50

End of Chapter 1