Introduction to

Managerial Accounting
and Cost Concepts
Management Accounting
What is Management Accounting?

It is the process of identifying, measuring,

accumulating, analyzing, preparing,
interpreting, and communicating
information that managers use to
fulfill organizational objectives.
 Differences Between Financial and
Managerial Accounting
Financial Managerial
Accounting Accounting
1. Users External persons who Managers who plan for
make financial decisions and control an organization
2. Time focus Historical perspective Future emphasis

3. Verifiability Emphasis on Emphasis on relevance

versus relevance verifiability for planning and control
4. Precision versus Emphasis on Emphasis on
timeliness precision timeliness

5. Subject Primary focus is on Focuses on segments

the whole organization of an organization

6. Requirements Must follow GAAP Need not follow GAAP

and prescribed formats or any prescribed format
 Planning and Controlling
What is decision making?

It is the purposeful choice from among

a set of alternative courses of action
designed to achieve some objective.

This is the core of the management process.

 Planning and Control Cycle
Formulating Long-and
Short-Term Plans
(Planning)
Begin

Comparing Actual Implementing

to Decision the Plans
Planned Performance Making (Directing and
(Controlling) Motivating)

Measuring
Performance
(Controlling)
 Planning and Controlling

The Management Process Internal Accounting System

Planning Budgets, Customer

Special Reports surveys
Corrections and Revisions

•Increase
of Plans and Actions

Competitor
Productivity analysis
Financial
Accounting Advertising
System impact
New items
Controlling report
•Actions Performance
•Evaluations Reports
Role of Budgets
 A budget is a quantitative expression of a
plan of action and is an aid to coordinating
and implementing the plan.
 Budgets are the chief devices for compelling
and disciplining management planning.
Role of
Performance Reports

Performance reports formalize controls and

provide feedback by comparing results with
plans and by highlighting variances.

Variances are deviations from the plan.

Performance Report

Budgeted Actual Variance

Amount Amount Amount
Revenues 25,000 19,000 6,000 U
Expenses 20,000 15,000 5,000 F
Net Income 5,000 4,000 1,000 U
 F = Favorable
 U = Unfavorable
 Cost and Cost Terminology

Cost is a resource sacrificed or forgone to achieve

a specific objective.

An actual cost is the cost incurred (a historical cost)

as distinguished from budgeted costs.

A cost object is anything for which a separate

measurement of costs is desired.
Cost and Cost Terminology

Cost Object
Cost
Accumulation Cost Object

Cost Object
Cost Tracing
Assignment
Allocating
 Direct Costs and Indirect Costs
Direct costs
 Costs that can be
easily and conveniently
traced to a unit of product or
other cost objective.
 Examples: direct material
and direct labor
Indirect costs
 Costs cannot be easily and
conveniently traced to a unit
of product or other cost
object.
 Example: manufacturing
overhead
 Direct and Indirect Costs

COST
COSTOBJECT
OBJECT
Direct Costs
Example: related with
Example:
Example:to toproduction
production
production volume-
Semi
Semimanufacturing
manufacturingitem
item
Limestone raw material
Like
Like–clinker
–clinker
Indirect Costs
Example: related with
The Time-depreciation for
building
Direct and Indirect Costs
Example
Direct Costs:
Maintenance Department SR40,000
Personnel Department SR20,600
Assembly Department SR75,000
Finishing Department SR55,000

Assume that Maintenance Department costs

are allocated equally among the production
departments.
How much is allocated to each department?
Direct and Indirect Costs Example

Maintenance
SR40,000

Assembly Finishing
Direct Costs Direct Costs
SR75,000 SR55,000
SR20,000 SR20,000
Allocated
Manufacturing Activities
Manufacturers . . .
 Buy raw materials.
 Produce and sell
finished goods.
Manufacturing Costs

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead
 Direct Materials
Those materials that become an integral part of the
product and that can be conveniently traced directly
to it.
Direct Labor
Those labor costs that can be easily traced to
individual units of product.
 Manufacturing Overhead
Manufacturing costs that cannot be traced directly to
specific units produced.

Examples:
Examples: Indirect
Indirect labor
labor and
and indirect
indirect materials
materials

Wages paid to employees Materials used to support

who are not directly the production process.
involved in production
work.
 Classifications of Costs
Manufacturing costs are often
classified as follows:

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Material
Material Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost
Nonmanufacturing Costs
Marketing and selling costs . . .
 Costs necessary to get the order and deliver the
product.
Administrative costs . . .
 All executive, organizational, and clerical costs.
Product Costs Versus Period Costs
Product costs include
direct materials, direct
labor, and manufacturing
overhead.
Period costs are not
included in product
costs. They are
expensed on the
income statement.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
Inventoriable Costs

Inventorial costs (assets)…

become cost of goods sold…

after a sale takes place.

Period 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.
Balance Sheet
Manufacturer
Current Assets
Materials waiting to
 Cash be processed.
 Receivables
 Prepaid Expenses
 Inventories
Raw Materials
Work in Process
Finished Goods
Completed products
awaiting sale.
The Income Statement
Cost of goods sold for manufacturers.
 Manufacturing Cost Flows
Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Period Costs Selling and

Administrative Administrative
 Manufacturing Company
BALANCE SHEET INCOME STATEMENT
Inventoriable
Costs Revenues
when deduct
Finished sales
Materials occur Cost of
Goods
Inventory Goods Sold
Inventory
Equals Gross Margin
deduct
Work in
Process Period
Inventory Costs
Equals Operating Income
 Merchandising Company

BALANCE SHEET INCOME STATEMENT

Inventoriable
Costs Revenues
when deduct
sales
Merchandise occur Cost of
Inventory
Purchases Goods Sold
Equals Gross Margin
deduct
Period
Costs
Equals Operating Income
 Many Meanings of Product Cost

A product cost is the sum of the costs

assigned to a product for a specific purpose.
1. Pricing and product emphasis decisions
2. Contracting with government agencies
3. Preparing financial statements for external
reporting under generally accepted
accounting principles
Quick Check 
Which of the following transactions would immediately
result in an expense? (There may be more than one
correct answer.)
A. Work in process is completed.
B. Finished goods are sold.
C. Raw materials are placed into production.
D. Administrative salaries are accrued and paid.
Inventory Flows
Beginning
Beginning Additions
Additions Available
Available
balance
balance + $$$
$$$
= $$$$$
$$$$$
$$
$$

Available
Available _ Withdrawals
Withdrawals
Ending
Ending
$$$$$
$$$$$ $$$
$$$
= balance
balance
$$
$$
Quick Check 
If your bank balance at the beginning of the month was
$1,000, you deposited $100 during the month, and
withdrew $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.
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw
materials inventory

Beginning
Beginning inventory
inventory
is
is the
the inventory
inventory
carried
carried overover from
from
the
the prior
prior period.
period.
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used As
Asitems
itemsare
are removed
removedfrom
fromraw
raw
in production materials
materialsinventory
inventoryandandplaced
placed into
into
the
theproduction
productionprocess,
process,they
theyare
are
called
called direct
direct materials.
materials.
Quick Check 
Beginning raw materials inventory was SR32,000.
During the month, SR276,000 of raw material was
purchased. A count at the end of the month revealed
that SR28,000 of raw material was still present. What is
the cost of direct material used?
A. SR276,000
B. SR272,000
C. SR280,000
D. SR 2,000
Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory + Direct labor
+ Raw materials + Mfg. overhead
purchased = Total manufacturing
= Raw materials costs
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Conversion

Conversion
materials inventory + Direct labor
+ Raw materials + Mfg. overhead
costs
costsarearecosts
costs
purchased = Total manufacturing incurred
incurredto to
= Raw materials costs convert
convert the
the
available for use direct
in production directmaterial
material
– Ending raw materials into
into aafinished
finished
inventory product.
product.
= Raw materials used
in production
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. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials
inventory All
Allmanufacturing
manufacturingcosts
costsincurred
incurred
= Raw materials used during
duringthe
theperiod
periodare
areadded
addedtotothe
the
in production
beginning
beginningbalance
balanceof
of work
work in
in
process.
process.
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending work in
process inventory
Costs
Costsassociated
associatedwith
withthe
the goods
goods that
that = Cost of goods
are
arecompleted
completedduring
duringthe
theperiod
periodare
are manufactured.
transferred
transferredto
tofinished
finished goods
goods
inventory.
inventory.
Quick Check 
Beginning work in process was SR125,000.
Manufacturing costs incurred for the month
were SR835,000. There were SR200,000 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. SR1,160,000
B. SR 910,000
C. SR 760,000
D. Cannot be determined.
Product Costs - A Closer Look
Quick Check 
Beginning finished goods inventory was
SR130,000. The cost of goods manufactured for
the month was SR760,000. And the ending
finished goods inventory was SR150,000. What
was the cost of goods sold for the month?
A. SR 20,000.
B. SR740,000.
C. SR780,000.
D. SR760,000.
Cost Drivers

What are cost drivers?

Output measures of resources and

activities are called cost drivers.
Cost Behavior

What is cost behavior?

It is how costs are related to, and affected

by, the activities of an organization.
 Cost Drivers

Production Example
Example costs: Example cost drivers:
Labor wages Labor hours
Supervisory salaries No. of people supervised
Maintenance wages No. of mechanic hours
Depreciation No. of machine hours
Energy Kilowatt hours
 Cost Drivers

How well the accountant does at identifying

the most appropriate cost drivers determines
how well managers understand cost behavior
and how well costs are controlled.
Cost Classifications for Predicting
Cost Behavior
How
Howaacost
costwill
willreact
reactto
to
changes
changesin
inthe
the level
levelof
of
business
businessactivity.
activity.
 Total variable costs
Total variable costs
change
changewhen
whenactivity
activity
changes.
changes.
 Total fixed costs remain
Total fixed costs remain
unchanged
unchangedwhen
whenactivity
activity
changes.
changes.
 Comparison of
Variable and Fixed Costs

A variable cost is a cost that changes in direct

proportion to changes in the cost driver.

A fixed cost is not immediately affected

by changes in the cost driver.
Rules of Thumb

Think of fixed costs as a total.

Total fixed costs remain unchanged
regardless of changes in cost-driver activity.
Rules of Thumb

Think of variable costs on a per-unit basis.

The per-unit variable cost remains
unchanged regardless of changes
in the cost-driver activity.
Relevant Range
 This rule of thumb holds true only within
reasonable limits.
 The relevant range is the limit of cost-driver
activity within which a specific relationship
between costs and the cost driver is valid.
 Relevant Range
Fixed Costs

SR16,000 –

SR12,000 – Relevant Range

SR8,000 –

SR4,000 ‫ــ‬
–

–
0 500 1,000 1,500 2,000 2,500
Volume in Units
Total Variable Cost
Your total long distance telephone bill is
based on how many minutes you talk.
Total Long Distance
Telephone Bill

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

Telephone Charge
Per Minute

Minutes Talked
Total Fixed Cost
Your monthly basic telephone bill probably does
not change when you make more local calls.
Telephone Bill
Monthly Basic

Number of Local Calls

 Fixed Cost Per Unit
The average cost per local call decreases as more
local calls are made.

Monthly Basic Telephone

Bill per Local Call

Number of Local Calls

 Cost Classifications for Predicting
Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
Cost Behavior
Examples of normally variable costs
Merchandisers Service Organizations
Cost of Goods Sold Supplies and travel

Manufacturers Merchandisers and

Direct Material, Direct Manufacturers
Labor, and Variable Sales commissions and
Manufacturing Overhead shipping costs

Examples of normally fixed costs

Merchandisers, manufacturers, and
service organizations
Real estate taxes, Insurance, Sales salaries
Depreciation, Advertising
The Activity Base
Units Machine
produced hours

A measure of the event

causing the incurrence of a
variable cost – a cost driver

Miles Labor
driven hours
 Types of Fixed Costs
Fixed Costs

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

Examples Examples
Depreciation on Advertising and
Buildings and Research and
Equipment Development
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.
Quick Check 
Which of the following costs would be variable
with respect to the number of people who buy a
ticket for a show at a movie theater? (There
may be more than one correct answer.)
A. The cost of renting the film.
B. Royalties on ticket sales.
C. Wage and salary costs of theater
employees.
D. The cost of cleaning up after the show.
 Fixed Costs and Relevant Range
Example: Office space is
available at a rental rate
of $30,000 per year in
increments of 1,000
square feet. As the
business grows more
space is rented,
increasing the total cost.

Continue
 Fixed Costs and Relevant Range

90
Thousands of Dollars

Total cost doesn’t

change for a wide
Rent Cost in

Relevant
60 range of activity,
Range and then jumps to a
new higher cost for
30 the next higher
range of activity.

0
0 1,000 2,000 3,000
Rented Area (Square Feet)
Quick Check 
Which of the following statements about cost behavior
are true?
a. Fixed costs per unit vary with the level of
activity.
b. Variable costs per unit are constant within the
relevant range.
c. Total fixed costs are constant within the relevant
range.
d. Total variable costs are constant within the
relevant range.
Cost Behavior Patterns Example

Bicycles by the Sea buys a handlebar

at $52 for each of its bicycles.
What is the total handlebar cost when
1,000 bicycles are assembled?
 Cost Behavior Patterns Example

1,000 units × $52 = $52,000

What is the total handlebar cost
when 3,500 bicycles are assembled?
3,500 units × $52 = $182,000
Cost Behavior Patterns Example

Bicycles by the Sea incurred $94,500 in

a given year for the leasing of its plant.
This is an example of fixed costs with
respect to the number of bicycles assembled.
Cost Behavior Patterns Example

What is the leasing (fixed) cost per bicycle

when Bicycles assembles 1,000 bicycles?
SR94,500 ÷ 1,000 = SR94.50
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 3,500 bicycles?
SR94,500 ÷ 3,500 = SR27
 Cost Drivers

The cost driver of variable costs is the level

of activity or volume whose change causes
the (variable) costs to change proportionately.
The number of bicycles assembled is a
cost driver of the cost of handlebars.
 Relevant Range Example

Assume that fixed (leasing) costs are $94,500

for a year and that they remain the same for a
certain volume range (1,000 to 5,000 bicycles).
1,000 to 5,000 bicycles is the relevant range.
 Relevant Range Example

120000
100000
Fixed Costs

80000
60000
40000 SR94,500
20000
0
0 1000 2000 3000 4000 5000 6000
Volume
Relationships of Types of Costs

Direct

Variable Fixed

Indirect
Interpret unit costs cautiously.
Total Costs and Unit Costs
Example

What is the unit cost (leasing and handlebars)

when Bicycles assembles 1,000 bicycles?
Total fixed cost SR94,500
+ Total variable cost SR52,000 = SR146,500
SR146,500 ÷ 1,000 = SR146.50
Total Costs and Unit Costs
Example
SR146,500
200000
SR52x
,50 0 +
150000 SR94
Total Costs

100000 $94,500

50000

0
0 500 1000 1500
Volume
Use Unit Costs Cautiously

Assume that Bicycles management uses a

unit cost of SR146.50 (leasing and wheels).
Management is budgeting costs for
different levels of production.
What is their budgeted cost for an
estimated production of 600 bicycles?
600 × SR146.50 = SR87,900
Use Unit Costs Cautiously

What is their budgeted cost for an estimated

production of 3,500 bicycles?
3,500 × SR146.50 = SR512,750
What should the budgeted cost be for an
estimated production of 600 bicycles?
Use Unit Costs Cautiously

Total fixed cost SR 94,500

Total variable cost (SR52 × 600) 31,200
Total SR125,700
SR125,700 ÷ 600 = SR209.50
Using a cost of SR146.50 per unit would
underestimate actual total costs if output
is below 1,000 units.
Use Unit Costs Cautiously

What should the budgeted cost be for an

estimated production of 3,500 bicycles?
Total fixed cost SR 94,500
Total variable cost (52 × 3,500) 182,000
Total SR276,500
SR276,500 ÷ 3,500 = SR79.00
Prime Costs

Direct Direct Prime

Materials + Labor = Costs
 Conversion Costs

Direct Manufacturing Conversion

Labor + Overhead = Costs

Indirect Indirect
Labor Materials Other
 Sunk Costs
Sunk costs cannot be changed by any decision. They are not differential
costs and should be ignored when making decisions.

Example: You bought an automobile that cost

SR10,000 two years ago. The SR10,000 cost is
sunk because whether you drive it, park it, trade
it, or sell it, you cannot change the SR10,000
cost.