Untitled
Managerial Accounting and Cost Concepts
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
© McGraw Hill LLC. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw Hill LLC.
Chapter 1: Needs of Management
Financial Accounting:
Concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators.
Managerial Accounting:
Concerned with providing information to managers within an organization to formulate plans, control operations, and make decisions.
Purposes of Cost Classification
Assigning costs to cost objects: Establishing a connection between costs and specific objectives or units.
Accounting for costs in manufacturing companies: Understanding how costs function within production systems.
Preparing financial statements: Structuring financial data for reporting purposes.
Predicting cost behavior: Analyzing how costs react to changes in activity levels.
Making decisions: Utilizing cost information to inform strategic choices.
Learning Objective 1
Understand cost classification used for assigning costs to cost objects:
Direct Costs:
Definition: 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:
Definition: Costs that cannot be easily and conveniently traced to a unit of product or other cost object.
Example: Manufacturing overhead.
Common Costs:
Definition: Indirect costs incurred to support a number of cost objects. These costs cannot be traced to any individual cost object.
Learning Objective 2
Identify and provide examples of basic manufacturing cost categories.
Classifications of Manufacturing Costs:
Direct Materials: Raw materials that become an integral part of the product and can be conveniently traced directly to it.
Example: A radio installed in an automobile.
Direct Labor: Labor costs that can be easily traced to individual units of product.
Example: Wages paid to automobile assembly workers.
Manufacturing Overhead: All manufacturing costs except direct materials and direct labor; cannot be readily traced to finished products.
Includes indirect labor costs and indirect materials that cannot be traced to specific units of product.
Examples of Manufacturing Overhead:
Depreciation of manufacturing equipment.
Utility costs.
Property taxes.
Insurance premiums incurred to operate a manufacturing facility.
Manufacturing Cost Classifications
Prime Costs: Combination of direct materials and direct labor costs.
Conversion Costs: Combination of direct labor and manufacturing overhead costs.
Nonmanufacturing Costs
Selling Costs: Costs incurred to secure orders and deliver products; can be either direct or indirect costs.
Administrative Costs: Executive, organizational, and clerical costs; can also be direct or indirect.
Learning Objective 3
Understand cost classifications used to prepare financial statements: Identify product costs and period costs.
Product Costs: Include all costs involved in acquiring or making a product, attach to units as they are manufactured and remain with inventory.
For manufacturing companies, product costs include:
Raw Materials: Materials that go into the final product.
Work in Process: Units of product still under construction.
Finished Goods Costs: Completed units not yet sold.
Transfer of Product Costs
Costs associated with manufacturing flow as follows:
From Raw Materials to Work in Process when direct materials are used.
Add Direct Labor and Manufacturing Overhead to convert raw materials into finished goods.
Transfer from Work in Process to Finished Goods for completed products.
Lastly, from Finished Goods to Cost of Goods Sold when sold to customers.
Cost Classifications for Financial Statements
Product Costs: Include direct materials, direct labor, and manufacturing overhead.
Period Costs: Include all selling and administrative costs.
Inventory Flow: Connects product costs and cost of goods sold on income statements and balance sheets.
Quick Check 1
Question: Identify a period cost in a manufacturing company.
Options:
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.
Learning Objective 4
Understand cost classifications used to predict cost behavior: Classes include variable costs, fixed costs, and mixed costs.
Cost Behavior Definition: How costs respond to changes in activity levels.
Variable Costs: Vary in total, proportional to changes in the level of activity.
Characteristics: Variable cost per unit remains constant.
Activity Base (Cost Driver): Measures productivity that generates variable costs.
Examples: Labor hours, units produced, machine hours, miles driven.
Fixed Costs: Remain constant regardless of activity changes.
Average fixed cost per unit inversely varies with activity levels.
Types of Fixed Costs:
Discretionary: Short-term adjustments possible by managerial decisions.
Committed: Long-term costs that cannot be reduced significantly in the short-term.
Linearity Assumption: Straight lines approximate curvilinear variable costs within relevant ranges.
Relevant Range of Fixed Costs
Fixed costs increase at specific intervals (e.g., each additional 1,000 square feet).
Mixed Costs
Contain both fixed and variable components.
Example: Utility costs, calculated as:
where
= total mixed cost,
= fixed monthly charge,
= variable cost per unit,
= activity level (e.g., kilowatt hours).
Mixed Cost Calculation Example
If fixed charge = $40, variable cost = $0.03/kWh, activity level = 2,000 kWh:
Resulting utility bill = $100.
Learning Objective 5
Understand cost classifications used in decision-making: Relevant and irrelevant costs.
Decision-Making Process: Determining costs relevant to alternatives, involves identifying differential costs and revenues, opportunity costs, and sunk costs.
Differential Costs
Definition: Difference in cost between alternatives; both differential costs and revenues are relevant for decisions.
Can be either fixed or variable.
Opportunity Costs
Definition: Potential benefits given up when selecting one alternative over others; often not recorded in accounting.
Example: Cost incurred by attending class instead of working.
Sunk Costs
Definition: Costs that have already been incurred and cannot be changed; should be ignored in decision-making.
Quick Check 3
Scenario: Deciding between driving or taking the train to Portland; determining relevance of the train ticket cost.
Options:
A. Yes, it is relevant.
B. No, it is not relevant.
Learning Objective 6
Prepare income statements for a merchandising company: Utilizing both traditional and contribution formats.
Traditional Format: Primarily for external reporting — structured around product costs related to goods sold and financial performance.
Contribution Format: Primarily for internal management; useful for cost-volume-profit analysis and segmented reporting, including budgeting and special decision-making.