203 CH1: Managerial and Cost Concepts

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Managerial Accounting and Cost Concepts

Learning Objectives

• understand cost classifications used for assigning costs to cost objects: direct and indirect costs

• identify and give examples of each of the three basic manufacturing cost categories

• understand cost classifications used to prepare financial statements: product costs and period costs

• understand cost classifications used to predict cost behavior: variable costs, fixed costs, and mixed costs

• understand cost classifications used in making decisions: relevant and irrelevant costs

• prepare income statements for a merchandising company using the traditional and contribution formats

product cost aka moh

• dm dl = period cost

• dl moh =

  • idm, idl, other

period cost also moh

• selling exp

• admin exp

direct cost/indirect cost

Chapter Outline:

• Cost Classifications for Assigning Costs to Costs Objects

  • Direct Cost

    • direct cost : cost that can be easily and conveniently traced to a specified cost object

      • ex : direct materials and direct labor

  • Indirect Cost

    • indirect cost : cost that cannot be easily and conveniently traced to a specific cost object

      • ex : manufacturing overhead

      • ex : factory manager salary incurred due to running entire factory, not incurred to product any one product

        • common cost (type of indirect cost): cost incurred to support number of cost objects but cannot be traced to them individually

• Cost Classifications for manufacturing Companies

  • manufacturing costs

    • direct materials

      • raw materials : materials that go into the final product; refers to any materials that are used in the final product; a finished product of one company can become the raw materials of another company

      • direct materials : raw materials that become that become an integral part of the finished product whose costs can be conveniently traced to the finished product

    • direct labor / touch labor

      • direct labor : labor costs that can be easily traced to individual units of product

      • prime cost : sum of direct materials and direct labor costs

    • manufacturing overhead (MOH)

      • includes all manufacturing costs except direct materials and direct labor

      • includes indirect materials and indirect labor

        • indirect materials : small raw items of material that may be an integral part of a finished product, but whose costs cannot be easily or conveniently traced to it

        • indirect labor : labor costs of workers that cannot be conveniently traced to a particular product

      • includes depreciation of manufacturing equipment, utility costs, property taxes, insurance, etc.

      • conversion cost : sum of direct labor and MOH

    • MOH?

      • DL = 60%

      • DM = 5% of total cost = $150

      • total cost = $300 = DM (150) + (DL (60% x 150) + MOH (40% x 150)) = 150

  • non-manufacturing costs (aka selling, general, and administrative (SG&A))

    • two categories (both can either be direct or indirect)

      • selling costs / order getting / order-filling costs : all costs incurred to secure customer orders and get finished product to customer

        • ex : advertising, shipping, sales, travel, sales commissions, sales salaries, costs of finished goods warehouse

        • can either be direct or indirect costs

          • ex : cost of ad campaign dedicated to one specific product is DC of that product, where salary of a marketing manager who oversees

      • administrative costs : all costs associated with general management of organization rather than with manufacturing or selling

        • ex : executive compensation, general accounting, legal counsel, secretarial, public relations, etc.

        • ex : salary of accounting manager in charge of accounts receivable collection in East region is a direct cost of the region

        • ex : salary of CFO who oversees all of company’s regions is indirect cost with respect to individual regions

• Cost Classifications for Preparing Financial Statements

  • companies need to categorize costs as product costs or period costs

  • costs are recognized as expenses on the income statement in the period that benefits from the cost

    • ex : company pay liability insurance in advance for 2 years

      • half as expense (insurance expense); other half as asset (prepaid insurance

    • product costs : all costs involved in acquiring or making a product

      • aka inventoriable costs

      • three inventory accounts that falls under product costs — raw materials, work in progress, finished goods

        • prior to being record in costs of goods sold on income statement

        • WIP : partially completed, not 100%

        • FG : completed units that have not yet been sold to customers

    • period costs : all costs that are not product costs

      • all selling and administrative expenses are treated as period costs

      • ex : sales commissions, advertising, executive salaries, public relations, rental costs of administrative offices

      • are expensed on the income statement in the period in which they were incurred using the usual rules of accrual accounting

        • period in which cost is incurred is not necessarily the period in which cash changes hands

• Cost Classifications for Predicting Cost Behavior

  • cost behavior : how a cost reacts to changes in the level of activity

    • as activity levels rises/falls, cost reacts by rising/falling as well

    • variable cost : cost that varies in direct proportion to changes in level of activity; constant per unit

      • must be with respect to something

      • activity base : a measure of whatever causes the incurrence of a variable cost

        • aka cost driver

    • fixed cost : cost that remains constant, in total, regardless of activity level

      • if activity level increases, average fixed cost per unit becomes progressively smaller

      • committed fixed costs : organizational investments with multiyear planning horizon that can’t be significantly reduced even for short periods of time without making fundamental changes

        • ex : investments in facilities and equipment

      • discretionary fixed costs (managed fixed costs) : fixed costs that arises from annual decisions by management to spend on certain fixed cost items, such as advertising and research

    • the linearity assumption and the relevant range

      • relevant range : range of activity within which the assumption the cost behavior is strictly linear is reasonably valid

    • mixed costs : contained both variable and fixed cost elements

      • mixed cost behavior

    • cost terminology-a closer look

      • steeper slop, higher variable cost per unit

• Cost Classifications for Decision Making

  • relevant and irrelevant costs

    • relevant costs : costs that should be considered when making decisions

    • relevant benefit : a benefit that should be considered when making decisions

    • differential cost and revenue

      • differential costs : a future cost that differs between any two alternatives

        • always relevant costs

        • incremental cost : increase in cost from one alternative to another

        • decremental cost : decrease in cost

        • can either be fixed or variable

        • ex :

      • differential revenue : future revenue that differs between any two alternatives

        • example of relevant benefit

    • irrelevant costs and benefits should be ignored when making decisions

    • sunk cost and opportunity cost

      • opportunity cost : the potential benefit that is given up when one alternative is selected over another

• Using Different Cost Classifications for Different Purposes

  • • the traditional format income statement

    • the contribution format income statement

2.12 Exercise: Direct and Indirect (cost : cost object)

1. wages of pediatric nurses : pediatric dpt : indirect

2. prescription drugs : particular patient : direct

3. heating the hospital : pediatric dpt : indirect

4. salary of the head of pediatrics : pediatric dpt : direct, ez to trace

5. salary of the head of pediatrics : particular pediatric pt: indirect, can’t be traced to each specific pt

6. hospital chaplain’s salary : particular patient : indirect, unless separately charged to specific patient, won’t be direct

7. lab tests by outside contractor : particular pt : indirect

8. lab tests by outside contractor : particular dpt : direct

2.14