Introduction

Scope of Managerial Accounting

Financial vs. Managerial Accounting
• Financial Accounting - Focus on financial statements
which are distributed to stockholders, lenders, analysts, and
others outside the organization. Prepared using GAAP
• Managerial Accounting – Focus on assisting management
in the operation of the company. This includes: analyzing a
company’s costs, assisting in financial decisions, profit
planning, calculating break-even points, capital budgeting,
and calculating costs of existing products in order to value
the company’s inventory and COGS (both used in financial
statements).
What Is Managerial Accounting about?
• A decision support system
• User perspective
• Forward looking
Management
Accounting

Planning Control
(facilitating (Influencing
decisions) decisions)
In this course…
We will cover the planning side

1. Capacity planning
2. Product planning
3. Budgeting
Planning? 4. Outsourcing
5. Pricing
Specifically
• We will focus on cost concepts, cost structure, cost
measurement
• The measurement and use of cost information for
“short-term” tactical decision making
• Pricing, promotions, responding to changing demand conditions
• The measurement and use of cost information for long-term
decision making
• How much to invest in resources such as people, equipment; which
products to pursue
Some Common Questions
• What is the cost of a product or a service?
• Is the “margin” sufficient?
• Is the pricing right?
• At what level should a company plan for the coming year?
• Will all the available resources be fully utilized?
• If not, what can be done?
Four-Step Framework for Decisions
Our Focus

1 2 3 4

First Step Second Step Third Step Fourth Step

Specify the Identify options Measure benefits Make the decision,
decision problem, (advantages) and choosing the option
including the costs (disadvantages) with the highest value
decision-maker’s to determine the value
goals (benefits reaped less
costs incurred) of each
option
Measuring and Estimating Costs
• What to measure?
• Relevance
• Opportunity cost
• How to measure?
• Variability
• Traceability
• Where to find information?
• Accounting records: how information is presented
The Concept of Relevance
• Only focus on items that are different across decision options
• If a cost or benefit is the same for all decision options, it is
not relevant
• Relevant only if it changes for at least one decision option
• Sunk cost
• Costs that have already been incurred in the past. Not relevant.
• Committed cost
• Costs that have been committed to in the past. Not relevant.
Problem 1: Motown Manufacturing

Refer to Session 1 Problem Set

Measuring and Estimating Costs
• What to measure?
• Relevance
• Opportunity cost
• How to measure?
• Variability
• Traceability
• Where to find information?
• Accounting records: how information is presented
The Concept of Opportunity Cost (OC)
• Opportunity cost is a commonly used term that most of us
understand.
• Consider the following example.
• Suppose there are three options in a decision:
• Option A: Value $80
• Option B: Value $60
• Option C: Value $75
The Concept of Opportunity Cost (OC)
• OC is the value of the next best option.
• Option A: Value $80 OC = $75
• Option B: Value $60 OC = $80
• Option C: Value $75 OC = $80
• You can also think of OC in terms of the gain or loss relative
to the next best.
• Option A: Gain of $5 relative to the next best option
• Option B: Loss of $20 relative to the next best option
• Option C: Loss of $5 relative to next best option
Properties of Opportunity Cost (OC)
• OC is decision specific.
• Suppose you are planning to buy a smart watch for $500.
• We say that the cost of the watch is $500. What is its OC?
• $500. Why?

• In a business context, the cost basis for every resource

involved in a decision is its opportunity cost.
Properties of Opportunity Cost (OC)
• OC can be:
• Positive: the watch example.

• Zero: a resource to be used in a decision context has zero OC

if it has no other use (The “special wood” already in stock in
Problem 1).

• Negative! We will do an example.

Problem 2: Wood Guardians

Refer to Session 1 Problem Set

Problem 2: Wood Guardians
a. Labor
• What is the OC of the labor for the job?
Problem 2: Wood Guardians
Materials
What is the OC in the following independent scenarios?

b. The chromic acid in stock would have been used for another job.

c. Suppose there is no other use for the chromic acid.

d. Suppose the only other choice is to dispose off the acid by spending $500.
Problem 2: Wood Guardians
Cost, OC, and pricing
• Consider the last scenario (costly disposal is the only other option). Considering only
materials and labor, what is the floor for the bid (i.e., the price at which there is no change
in profit)?

• What is the price to charge?

• Takeaways?
Measuring and Estimating Costs
• What to measure?
• Relevance
• Opportunity cost
• How to measure?
• Variability
• Traceability
• Where to find information?
• Accounting records: how information is presented
Three-Step Model for Estimating Costs and Benefits

Cost Cost Cost

behavior estimation prediction

Build model of Use historical data to Use estimated

expected test model and to parameters to forecast
relationship between determine costs at a particular
cost and activity parameters activity level

• Cost structure specifies relation between activity and cost

(concept: variability).
• We also have to consider confidence in estimate
(concept: traceability).
Problem 3: Jayhawk/Zagg River Rafting

Refer to Session 1 Problem Set

Variability in Cost Behavior
• Variability is defined in relation to some “cost driver.”
• A cost driver is a physical activity
• Examples: production/sales volume, number of labor hours,
number of customer calls, number of miles traveled
• Fixed costs are incurred irrespective of volume of
production.
• Variable costs vary in direct proportion to volume.
Visualizing Cost Behavior
Total Fixed and Variable Per Unit Costs
Fixed costs
Cost per unit

Cost
Fixed
Variable
Variable
cost/unit
Activity (units) Activity (units)

Step Costs
Cost

Activity (units)
Cost Hierarchy
• Useful to think of cost as occurring at “levels” of activity
• Unit: Proportional to volume of activity materials, fuel cost,
commissions.
• Batch: Incurred once per batch. Set up of machine. Ordering
costs.
• Product/process: Associated with a particular product or process.
Design, special equipment, patents, advertising.
• Facility: Cost of doing business. Property taxes, registration fees.
• The “fixed/variable” cut is a crude partition
• But, it gets us most of the way in many situations.
An Example of Cost Hierarchy
Unit-level costs
• Direct materials such as the cost of paper, and direct
labor used in printing
Batch-level costs
• Setups and production planning required to prepare
printing machines
Product-level costs
• Artwork and adding a new font to a product line
Facility-level costs
• Factory rent and property taxes
Traceability of Costs
• Traceability is the degree to which we can directly relate a cost to a
cost object or a decision option.
• Traceable costs are called direct costs.
• Costs that are not traceable are called indirect costs.
• In manufacturing:
• Material and labor costs are direct costs.
• Overhead costs such as utilities and supervision are indirect costs.
• In a hospital:
• Drugs and medical supplies are direct costs.
• Nursing staff and admin staff are indirect costs.
• Indirect costs are typically “allocated” to products or services.
Example
• Marcella manages a house cleaning services company. She has five employees.
She offers two types of services,
• Regular cleaning (40 per month):
• Materials cost: $15 (variable)
• Labor cost: $90 (variable)
• Transportation: $10 (variable)
• Deep cleaning (15 per month):
• Materials cost: $40 (variable)
• Labor cost: $180 (variable)
• Transportation: $10 (variable)
• Marcella’s monthly salary ($2,000)
• Other monthly costs ($1,500)
Example
How much does each regular cleaning service call and each deep
cleaning service call cost?
• Traceable costs are easy to handle
• Traceable costs per call of regular cleaning service = $15+ $90 + $10 = $115
• Traceable costs per call of deep cleaning service = $40+ $180 + $10 = $230
• What about the indirect costs of $3500 per month?
• Allocate based on number of calls
• $3500/55 = $63 per call?
• Can we have confidence in this estimate?
• Allocations are a big issue in Management Accounting!
Measuring and Estimating Costs
• What to measure?
• Relevance
• Opportunity cost
• How to measure?
• Variability
• Traceability
• Where to find information?
• Accounting records: how information is presented
Information Flow
Suppliers Customers

Acquire Process Deliver

resources resources product

Financial and Plan Control

GAAP nonfinancial data
Auditors

Financial Estimate,
statements validate, predict
Management
accounting
Financial Decision useful
accounting Managers
information

Shareholders, lenders, government

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