MANAGEMENT ACCOUNTING

Basic Concepts & Cost Behavior Analysis

Cost - is cash or cash equivalent necessary to attain an objective such as acquiring goods or services, performing a function or producing and
distributing a product.

Cost of Sales, Operating Expenses and Losses Distinguished

- Cost of sales or costs of goods sold are those production costs incurred related to the units sold.
- Expenses are those incurred in selling goods, distributing goods and managing a business (operating expenses).
- Both costs and expenses give benefits to the business.
- Losses do not give any benefit to the business.

Different Costs for different purposes (Classifications of Costs)

A. As to type
1. Product Costs – costs incurred to manufacture the product. Product costs of the units sold are recognized as expense (COGS) while
product costs of the unsold units become the costs of inventory.
2. Period Costs – non-manufacturing costs that include selling, administrative and research and development costs. These costs are expensed
in the period of incurrence and do not become part of the cost of inventory.

B. As to function
1. Manufacturing Costs
2. Non-manufacturing Costs

C. As to traceability
1. Direct Costs – related to a particular cost object and can economically and effectively be traced to that object. (Direct Materials and Direct
Labor)
2. Indirect Costs – related to a cost object, but cannot practically, economically and effectively be traced to such cost object. Cost assignment
is done by allocating the indirect cost to the related cost objects.

D. For decision-making
1. Relevant Costs – future costs that will differ under alternative courses of action.
2. Differential Costs – difference in costs between any two alternative courses of action.
a. Incremental Cost – increase in cost from one alternative to another.
b. Decremental Cost – decrease in cost from one alternative to another.
3. Opportunity Costs – income or benefit given up when one alternative is selected over another.
4. Sunk, Past or Historical Costs – already incurred and cannot be changed by any decision made now or to be made in the future.

E. As to relation to an accounting period:

1. Capital Expenditure – are those costs incurred to benefit several periods.
2. Revenue Expenditure – are those costs incurred to benefit only one period.

F. As to behavior (Reaction to changes in Cost Driver)

1. Variable Costs – are costs that change directly and proportionately with the level of activity.

2. Fixed Costs – are costs that do not change with changing levels of activity. In other words, they remain constant regardless of the change
in activity level.

a. Committed Fixed Cost – results from an organization's ownership or use of facilities and its basic organizational structure (e.g.,
property taxes, depreciation).
b. Discretionary Fixed Cost – is a cost that can be cut back more easily in bad economic times without doing serious harm to
organizational goals and objectives.

3. Mixed Costs – are costs that have the characteristics of both variable and fixed costs.

Cost Behavior - refers to the way costs change with respect to a change in the activity level, such as production or sales volume, labor or machine
hours, etc. There are costs which remain constant, some change directly or proportionately with the activity level, and others change in different
patterns.

Types of Cost Total amount Amount per unit

1. FIXED Constant Decreases as production increases
2. VARIABLE Increases as production increases Constant
3. MIXED Increases less proportionately (vs. total variable costs) Decreases less proportionately (vs. fixed cost per unit) as
as production increases production increases
Cost Behavior Assumptions

A. Relevant Range Assumption

Relevant range refers to the range of activity within which the cost behavior patterns are valid. Any level of activity outside this range may
show a different cost behavior pattern.

B. Time Assumption
The cost behavior patterns identified are true only over a specified period of time. Beyond this, the cost may show a different cost behavior
pattern.

C. Linearity Assumption
The cost is assumed to manifest a linear relationship over a relevant range despite its tendency to show otherwise over the long run.

Equation “Y = a + bX”

Y = total costs (dependent variable)

a = total fixed costs (y-intercept-vertical axis-intercept)
b = variable cost per unit (slope of the line)
X = activity or cost driver (independent variable)

Cost Estimation: Segregation of Mixed Costs into Fixed and Variable Elements

1. High-Low Method 4. Engineering Method

2. Least-Squares Method 5. Account Analysis Method
3. Scattergraph (Scatter Diagram) Method

High-Low Method

The fixed and variable elements of the mixed costs are computed from two sampled data points – the highest and lowest points as to
activity level or cost driver. For analysis purposes, the high-low method usually produces a reasonable, not precise estimate. However, this method is
criticized because it ignores much of the available data by concentrating on only the extreme points.

Least-Squares Method

Least-squares method is a statistical technique that investigates the association between dependent and independent variables. This method
determines the line of best fit for a set of observations by minimizing the sum of the squares of the vertical deviations between actual points and the
regression line.
 If there is only one independent variable, the analysis is known as SIMPLE REGRESSION.
 If the analysis involves multiple independent variables, it is known as MULTIPLE REGRESSION.

In the method of least squares, the deviation is the difference between the predicted and actual costs.

Formula:
∑y = na + b∑x
∑xy = a∑x + b ∑x²

Illustration: High-Low vs. Least-Squares Method

Char Company provides a personalized training program that is popular with many companies. The number of programs offered over the last five
months, and the costs of offering these programs are as follows:

Programs Offered Costs Incurred

January 55 P 15,400
February 45 14,050
March 60 18,000
April 50 14,700
May 75 19,000

Required:

1. Using the high-low method, compute the variable cost per program and the total fixed cost per month.

2. Using the least squares regression method, compute the variable cost per program and the total fixed cost per
month.
Illustration: High-Low vs. Least-Squares Method

OKC Company’s total overhead costs at various levels of activity are presented below:
Month Machine Hours Total Overhead Costs
March 500 P 970
April 400 851
May 600 1,089
June 700 1,208

The breakdown of the overhead costs in April at 400 machine hour level of activity is as follows:
Supplies (variable) P 260
Salaries (fixed) 300
Utilities (mixed) 291
Total P 851

Required:
1. Determine how much of June’s overhead cost of P1,208 consisted of utilities cost.
2. Using high-low method, determine the cost function for utilities cost.
3. Using high-low method, determine the cost function for total overhead cost.
4. Using least squares method, determine the cost function for total overhead costs.
5. What would be the total overhead costs if operating level is at 450 machine hours?

Scattergraph (Scatter Diagram) Method

All observed costs at various activity levels are plotted on a graph. Based on sound judgment, a regression line is then fitted to the plotted
points to represent the line function. Its principal advantage over the high-low method is that it considers more than two points. The major objective
of this method is to develop an equation to predict future costs.

Engineering Method

This method is best used for estimating costs for totally new activities. It can detail each step required to perform an operation and
sometimes can be quite expensive to use.

Account Analysis Method

Each account is classified as either fixed or variable based on experience and judgment of accounting and other qualified personnel in the
organization.

Conference Method

Costs are classified based on opinions from various company departments such as purchasing, process engineering, manufacturing,
employee relations and so on.

REVIEW QUESTIONS

1. Cost is the monetary measure of the amount of resources given up in obtaining goods and services. Cost may be classified as unexpired or
expired. Which of the following costs is not always considered to be expired immediately upon being recognized?
a. Salesmen’s commission c. Cost of goods sold
b. Depreciation expense for factory equipment d. Salary of the company president

2. Product costs or inventoriable costs

a. are charged to expense when products become part of the FG inventory.
b. include only the prime costs of producing a product.
c. are treated as assets before the products are sold.
d. include only the conversion costs of producing products.

3. Product costs
a. are always expensed in the same period in which they are incurred.
b. are inventoriable costs.
c. vary directly with changes in the cost driver.
d. are always charged to an asset account in the same period in which thy are incurred.

4. Manufacturing costs do not include

a. prime costs
b. conversion costs
c. indirect materials
 d. salary of the company president, under whom is the vice president for production

5. Direct labor cost is a

a. prime cost b. conversion cost c. product cost d. all of the above

6. A fixed cost that would be considered a direct cost is

a. salary of the sales manager when the cost object is the sales department.
b. salary of the controller when the cost object is a unit of product.
c. fees of the board of directors when the cost object is the production department.
d. the rental cost of the finished goods warehouse when the cost object is the accounting department.

7. Which of the following is a direct product cost?

a. Wood in a furniture factory.
b. Salary of the foreman in the assembly division of an automobile company.
c. Depreciation of factory equipment.
d. Salesmen’s commission

8. The variable portion of the semi-variable cost of electricity for a manufacturing plant is a
Product Cost Prime Cost Conversion Cost
a. No No Yes
b. Yes Yes No
c. Yes Yes Yes
d. Yes No Yes

9. Depreciation computed using the straight-line method is classified as

a. variable cost b. fixed cost c. relevant cost d. opportunity cost

10. These costs are long-term in nature and cannot be eliminated even for short periods of time without affecting the profitability or long-term
goals of the firm.
a. Avoidable costs b. Committed fixed costs c. Variable costs d. Controllable costs

Items 11 to 13 are based on the following information:

Kratos Company is preparing a budget for the next year and requires a breakdown of the factory maintenance cost into the fixed and
variable elements.

The maintenance costs and machine hours (the selected cost driver) for the past six months are as follows:

Maintenance Costs Machine Hours

Jan P 15,500 1,800
Feb 10,720 1,230
Mar 15,100 1,740
Apr 15,840 2,190
May 14,800 1,602
June 10,600 1,590

Using the high-low method, compute for the following:

11. Variable rate of maintenance cost per machine hour

12. Average annual fixed maintenance cost
13. Average rate per hour at a level of P1,500 machine hours

14. When production (in units) decreases, the average cost per unit of product increases. This increase in the average cost per unit is due to the
a. increase in variable cost per unit c. increase in total variable costs
b. increase in fixed cost per unit d. increase in total fixed costs

15. The salaries of the factory janitorial and maintenance staff should be classified as
a. direct labor cost b. period cost c. prime cost d. factory overhead cost

16. Which of the following items is typically an example of an indirect cost of a cost object?
a. courier charges for shipment delivery c. direct labor
b. Manufacturing plant electricity d. wood used for furniture manufacturer

17. Which one of the following is a variable cost in an insurance company?

a. Rent b. sales commissions c. president’s salaryd. property taxes

18. All of the following statements are correct, except

 a. costs may be indirect and variable c. costs may be direct and variable
b. costs may not be indirect and fixed d. costs may be direct and fixed

19. Which of the following statements would be incorrect in a manufacturing plant?

a. completed goods are included in the finished goods inventory
b. partially completed goods are part of the work in process category
c. work in process may also be called goods in process
d. materials put into product are included in the direct materials category

20. Selling and administrative costs are classified as

a. period costs b. product costs c. conversion costs d. prime costs