Introduction to Managerial Accounting and Cost Concepts

1
Introduction to Managerial Accounting and Cost
Concepts
2
Management Accounting
What is Management Accounting?
It is the process of identifying,
measuring, accumulating, analyzing,
preparing, interpreting, and communicating informa
tion that managers use to fulfill organizational
objectives.
3
Differences Between Financial and Managerial
Accounting
4
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.
5
Work of Management

Planning
Directing and Motivating
Controlling
6
Planning and Control Cycle
Formulating Long-andShort-Term Plans (Planning)
7
Planning and Controlling
The Management Process Internal Accounting System

• Planning
• Increase
• Productivity

Budgets, Special Reports
Customer surveys
Corrections and Revisions of Plans and Actions
Competitor analysis
Financial Accounting System
Advertising impact
New items report

• Controlling
• Actions
• Evaluations

Performance Reports
8
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.

9
Role ofPerformance Reports
Performance reports formalize controls
and provide feedback by comparing results
with plans and by highlighting variances.
Variances are deviations from the plan.
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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

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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.
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Cost and Cost Terminology
Cost Object
Cost Accumulation
Cost Object
Cost Object
Cost Assignment
Tracing
Allocating
13
Direct Costs and Indirect Costs

• Direct costs
• Costs that can beeasily 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

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Direct and Indirect Costs
COST OBJECT Example Sports Illustrated
magazine
Direct Costs Example Paper on
which Sports Illustrated magazine is printed
Indirect Costs Example Lease cost
for Time-Warner building housing the senior
editors of its magazine
15
Direct and Indirect CostsExample
Direct Costs Maintenance Department 40,000 Per
sonnel Department 20,600 Assembly
Department 75,000 Finishing
Department 55,000
Assume that Maintenance Department costs
are allocated equally among the production
departments.
How much is allocated to each department?
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Direct and Indirect Costs Example
Maintenance 40,000
Assembly Direct Costs 75,000
Finishing Direct Costs 55,000
20,000
20,000
Allocated
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Comparing Merchandising and Manufacturing
Activities

• Merchandisers . . .
• Buy finished goods.
• Sell finished goods.

• Manufacturers . . .
• Buy raw materials.
• Produce and sell finished goods.

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Manufacturing Costs
The Product
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Direct Materials

• Those materials that become an integral part of
  the product and that can be conveniently traced
  directly to it.

Example A radio installed in an automobile
20
Direct Labor

• Those labor costs that can be easily traced to
  individual units of product.

Example Wages paid to automobile assembly
workers
21
Manufacturing Overhead

• Manufacturing costs that cannot be traced
  directly to specific units produced.

Examples Indirect labor and indirect materials
22
Classifications of Costs

• Manufacturing costs are oftenclassified as
  follows

DirectMaterial
DirectLabor
ManufacturingOverhead
23
Nonmanufacturing Costs

• Marketing and selling costs . . .
• Costs necessary to get the order and deliver the
  product.
• Administrative costs . . .
• All executive, organizational, and clerical costs.

24
Quick Check ?

• Which of the following costs would be
  considered manufacturing overhead at Boeing?
  (More than one answer may be correct.)
• A. Depreciation on factory forklift trucks.
• B. Sales commissions.
• C. The cost of a flight recorder in a Boeing 767.
• D. The wages of a production shift supervisor.

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Quick Check ?

• Which of the following costs would be
  considered manufacturing overhead at Boeing?
  (More than one answer may be correct.)
• A. Depreciation on factory forklift trucks.
• B. Sales commissions.
• C. The cost of a flight recorder in a Boeing 767.
• D. The wages of a production shift supervisor.

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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.

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Inventoriable Costs
Inventoriable costs (assets)
become cost of goods sold
after a sale takes place.
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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.
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Quick Check ?

• 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.

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Quick Check ?

• 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.

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Balance Sheet

• Merchandiser
• Current assets
• Cash
• Receivables
• Prepaid expenses
• Merchandise inventory

• Manufacturer
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Inventories
• Raw Materials
• Work in Process
• Finished Goods

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Balance Sheet

• Merchandiser
• Current assets
• Cash
• Receivables
• Prepaid expenses
• Merchandise inventory

• Manufacturer
• Current Assets
• Cash
• Receivables
• Prepaid Expenses
• Inventories
• Raw Materials
• Work in Process
• Finished Goods

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The Income Statement

• Cost of goods sold for manufacturers differs
  only slightly from cost of goods sold for
  merchandisers.

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Manufacturing Cost Flows
Income StatementExpenses
Balance
Sheet Costs
Inventories
Selling andAdministrative
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Manufacturing Company
INCOME STATEMENT
BALANCE SHEET
Inventoriable Costs
Revenues
when sales occur
deduct
Materials Inventory
Finished Goods Inventory
Cost of Goods Sold
Equals Gross Margin deduct
Work in Process Inventory
Period Costs
Equals Operating Income
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Merchandising Company
INCOME STATEMENT
BALANCE SHEET
Inventoriable Costs
Revenues
when sales occur
deduct
Merchandise Purchases
Inventory
Cost of Goods Sold
Equals Gross Margin deduct
Period Costs
Equals Operating Income
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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
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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.

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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.

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Inventory Flows
41
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.

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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.

1,000 100 1,100 1,100 - 300 800
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Product Costs - A Closer Look
Beginning inventory is the inventory carried over
from the prior period.
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Product Costs - A Closer Look
As items are removed from raw materials inventory
and placed into the production process, they
arecalled direct materials.
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Quick Check ?

• Beginning raw materials inventory was 32,000.
  During the month, 276,000 of raw material was
  purchased. A count at the end of the month
  revealed that 28,000 of raw material was still
  present. What is the cost of direct material
  used?
• A. 276,000
• B. 272,000
• C. 280,000
• D. 2,000

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Quick Check ?

• Beginning raw materials inventory was 32,000.
  During the month, 276,000 of raw material was
  purchased. A count at the end of the month
  revealed that 28,000 of raw material was still
  present. What is the cost of direct material
  used?
• A. 276,000
• B. 272,000
• C. 280,000
• D. 2,000

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Product Costs - A Closer Look
48
Product Costs - A Closer Look
Conversion costs are costs incurred to convert
the direct material into a finished product.
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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.

50
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.

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Product Costs - A Closer Look
All manufacturing costs incurred during the
period are added to the beginning balance of work
in process.
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Product Costs - A Closer Look
Costs associated with the goods that are
completed during the period are transferred to
finished goods inventory.
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Quick Check ?

• Beginning work in process was 125,000.
  Manufacturing costs incurred for the month were
  835,000. There were 200,000 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. 1,160,000
• B. 910,000
• C. 760,000
• D. Cannot be determined.

54
Quick Check ?

• Beginning work in process was 125,000.
  Manufacturing costs incurred for the month were
  835,000. There were 200,000 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. 1,160,000
• B. 910,000
• C. 760,000
• D. Cannot be determined.

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Product Costs - A Closer Look
56
Quick Check ?

• Beginning finished goods inventory was
  130,000. The cost of goods manufactured for the
  month was 760,000. And the ending finished goods
  inventory was 150,000. What was the cost of
  goods sold for the month?
• A. 20,000.
• B. 740,000.
• C. 780,000.
• D. 760,000.

57
Quick Check ?

• Beginning finished goods inventory was
  130,000. The cost of goods manufactured for the
  month was 760,000. And the ending finished goods
  inventory was 150,000. What was the cost of
  goods sold for the month?
• A. 20,000.
• B. 740,000.
• C. 780,000.
• D. 760,000.

130,000 760,000 890,000 890,000 -
150,000 740,000
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Cost Drivers
What are cost drivers?
Output measures of resources and activities are
called cost drivers.
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Cost Behavior
What is cost behavior?
It is how costs are related to, and affected by,
the activities of an organization.
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Cost Drivers
Production Example

• Example costs
• Labor wages
• Supervisory salaries
• Maintenance wages
• Depreciation
• Energy

• Example cost drivers
• Labor hours
• No. of people supervised
• No. of mechanic hours
• No. of machine hours
• Kilowatt hours

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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.
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Cost Classifications for Predicting Cost Behavior

• How a cost will react to changes in the level
  of business activity.
• Total variable costs change when activity
  changes.
• Total fixed costs remain unchanged when activity
  changes.

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

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Relevant Range
16,000 12,000 8,000 4,000

Fixed Costs
Relevant Range
0 500 1,000 1,500 2,000
2,500
Volume in Units
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Total Variable Cost

• Your total long distance telephone bill is
  based on how many minutes you talk.

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Variable Cost Per Unit

• The cost per long distance minute talked is
  constant. For example, 10 cents per minute.

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Total Fixed Cost

• Your monthly basic telephone bill probably
  does not change when you make more local calls.

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Fixed Cost Per Unit

• The average cost per local call decreases as more
  local calls are made.

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Cost Classifications for Predicting Cost Behavior
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Cost Behavior
Examples of normally variable costs
Service Organizations Supplies and travel
Merchandisers Cost of Goods Sold
Merchandisers and Manufacturers Sales commissions
and shipping costs
Manufacturers Direct Material, Direct Labor, and
Variable Manufacturing Overhead
Examples of normally fixed costs
Merchandisers, manufacturers, and service
organizations Real estate taxes, Insurance, Sales
salariesDepreciation, Advertising
74
The Activity Base
A measure of the event causing the incurrence
of a variable cost a cost driver
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Types of Fixed Costs
Fixed Costs
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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.

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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.

78
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.

79
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.

80
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.

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Fixed Costs and Relevant Range
90
Total cost doesnt change for a wide range of
activity, and then jumps to a new higher cost for
the next higher range of activity.
Relevant Range
60
Rent Cost in Thousands of Dollars
30
0
0 1,000 2,000
3,000 Rented Area (Square Feet)
82
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.

83
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.

84
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?
85
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
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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.
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Cost Behavior Patterns Example
What is the leasing (fixed) cost per bicycle when
Bicycles assembles 1,000 bicycles?
94,500 1,000 94.50
What is the leasing (fixed) cost per bicycle when
Bicycles assembles 3,500 bicycles?
94,500 3,500 27
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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.
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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.
90
Relevant Range Example
94,500
91
Relationships of Types of Costs
Direct
Variable
Fixed
Indirect
92

• Interpret unit costs cautiously.

93
Total Costs and Unit Costs Example
What is the unit cost (leasing and
handlebars) when Bicycles assembles 1,000
bicycles?
Total fixed cost 94,500 Total variable cost
52,000 146,500
146,500 1,000 146.50
94
Total Costs and Unit CostsExample
146,500
94,500 52x
94,500
95
Use Unit Costs Cautiously
Assume that Bicycles management uses a unit cost
of 146.50 (leasing and wheels).
Management is budgeting costs for different
levels of production.
What is their budgeted cost for an estimated
production of 600 bicycles?
600 146.50 87,900
96
Use Unit Costs Cautiously
What is their budgeted cost for an
estimated production of 3,500 bicycles?
3,500 146.50 512,750
What should the budgeted cost be for an estimated
production of 600 bicycles?
97
Use Unit Costs Cautiously
Total fixed cost 94,500 Total variable
cost (52 600) 31,200 Total 125,
700
125,700 600 209.50
Using a cost of 146.50 per unit
would underestimate actual total costs if
output is below 1,000 units.
98
Use Unit Costs Cautiously
What should the budgeted cost be for an estimated
production of 3,500 bicycles?
Total fixed cost 94,500 Total variable
cost (52 3,500) 182,000 Total 276,5
00
276,500 3,500 79.00
99
Prime Costs
Direct Materials
Prime Costs
Direct Labor


100
Conversion Costs
Manufacturing Overhead
Direct Labor
Conversion Costs


Other
Indirect Materials
Indirect Labor
101
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
10,000 two years ago. The 10,000 cost is sunk
because whether you drive it, park it, trade it,
or sell it, you cannot change the 10,000 cost.
102
Quick Check ?

• 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.

103
Quick Check ?

• 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.

104
End of Module 1