Managerial

Accounting and Cost

Concepts
CHAPTER 1

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

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 1-2

Needs of Management
Financial accounting is concerned with
reporting financial information to external
parties, such as stockholders, creditors, and
regulators.

Managerial accounting is concerned with

providing information to managers within an
organization so that they can formulate plans,
control operations, and make decisions.

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 1-3

Purposes of Cost Classification

1. Assigning costs to cost objects

2. Accounting for costs in manufacturing
companies
3. Preparing financial statements
4. Predicting cost behavior in response to changes
in activity
5. Making decisions

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 1-4

Learning Objective 1

Understand cost
classifications used for
assigning costs to cost
objects: direct costs and
indirect costs.

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 Assigning Costs to Cost
1-5

Objects
Direct costs Indirect costs
• Costs that can be • Costs that cannot be easily
easily and conveniently and conveniently traced to
traced to a unit of product a unit of product or other
or other cost object. cost object.
• Examples: direct material • Example: manufacturing
and direct labor overhead

Common costs
• Indirect costs incurred to support a number of cost
objects. These costs cannot be traced to any
individual cost object.

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 1-6

Learning Objective 2

Identify and give examples

of each of the three basic
manufacturing cost
categories.

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 1-7

Classifications of Manufacturing
Costs

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

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 1-8

Direct Materials
Direct materials are raw materials that
become an integral part of the product and
that can be conveniently traced directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile

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 1-9

Direct Labor
Direct labor costs are those labor costs that
can be easily traced to individual units of
product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly
workers
workers

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 1-10

Manufacturing Overhead
Manufacturing overhead includes all
manufacturing costs except direct material
and direct labor. These costs cannot be readily
traced to finished products.

Includes indirect materials Includes indirect labor costs

that cannot be easily or that cannot be easily or
conveniently traced to conveniently traced to
specific units of product. specific units of product.

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Manufacturing Overhead –
1-11

Examples
Examples
Examples of
of manufacturing
manufacturing overhead:
overhead:
•• Depreciation
Depreciation of
of manufacturing
manufacturing equipment
equipment
•• Utility
Utility costs
costs
•• Property
Property taxes
taxes
•• Insurance
Insurance premiums
premiums incurred
incurred to
to operate
operate aa
manufacturing
manufacturing facility
facility

Only those indirect costs associated with

operating the factory are included in
manufacturing overhead.

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 Prime Costs and Conversion
1-12

Costs
Manufacturing costs are often
classified as follows:

Direct Direct Manufacturing

Material Labor Overhead

Prime Conversion
Cost Cost

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 1-13

Nonmanufacturing Costs

Selling Administrative
Costs Costs

Costs necessary to All executive,

secure the order and organizational, and
deliver the product. clerical costs.
Selling costs can be Administrative costs
either direct or indirect can be either direct or
costs. indirect costs.
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 1-14

Learning Objective 3

Understand cost
classifications used to
prepare financial
statements: product costs
and period costs.

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 1-15

Product Costs
Product costs includes all the costs that are
involved in acquiring or making a product.

Product
Product costs
costs “attach”
“attach” toto aa unit
unit of
of product
product as
as itit
is
is purchased
purchased oror manufactured
manufactured and and they
they stay
stay
attached
attached to
to each
each unit
unit of
of product
product as as long
long as
as itit
remains
remains in
in inventory
inventory awaiting
awaiting sale.
sale.

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 1-16

Manufacturing Product Costs

For
For manufacturing
manufacturing companies,
companies, product
product costs
costs
include:
include:
•• Raw
Raw materials:
materials: includes
includes any
any materials
materials that
that go
go
into
into the
the final
final product.
product.
•• Work
Work in in process:
process: consists
consists of
of units
units of
of product
product
that
that are
are only
only partially
partially complete
complete and
and will
will require
require
further
further work
work before
before they
they are
are ready
ready for
for sale
sale to
to
the
the customer.
customer.
•• Finished
Finished goods
goods costs:
costs: consists
consists ofof completed
completed
units
units of
of product
product that
that have
have not
not yet
yet been
been sold
sold to
to
customers.
customers.
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 1-17

Transfer of Product Costs

• When direct materials are used in production, their
costs are transferred from Raw Materials to Work in
Process.
• Direct labor and manufacturing overhead costs are
added to Work in Process to convert direct materials
into finished goods.
• Once units of product are completed, their costs are
transferred from Work in Process to Finished
Goods.
• When a manufacturer sells its finished goods to
customers, the costs are transferred from Finished
Goods to Cost of Goods Sold.

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 1-18

Cost Classifications for Preparing

Financial Statements
Product costs include Period costs include all
direct materials, direct selling costs and
labor, and manufacturing administrative costs.
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement

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 1-19

Quick Check 1
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.
E. Sales commissions.

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 1-20

Quick Check 1a
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.
E. Sales commissions.

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 1-21

Learning Objective 4

Understand cost
classifications used to
predict cost behavior:
variable costs, fixed costs,
and mixed costs.

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 1-22

Cost Classifications for

Predicting Cost Behavior

Cost behavior refers to how a cost will

react to changes in the level of activity.
The most common classifications are:
• Variable costs.
• Fixed costs.
• Mixed costs.

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 1-23

Variable Cost

A cost that varies, in total, in direct

proportion to changes in the level of
activity.

A variable cost per unit is constant.

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 1-24

An Activity Base (Cost Driver)

Units Machine
produced hours

A measure of what
causes the
incurrence of a
variable cost

Miles Labor
driven hours
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 1-25

Fixed Cost

A cost that remains constant, in total,

regardless of changes in the level of
the activity.

If expressed on a per unit basis, the

average fixed cost per unit varies
inversely with changes in activity.

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 1-26

Types of Fixed Costs

Committed Discretionary
Long-term, cannot May be altered in the
be significantly short-term by current
reduced in the short managerial decisions
term

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 1-27

The Linearity Assumption and

the Relevant Range

Economist’s AA straight
straight line
line
closely
closely
Curvilinear Cost approximates
approximates aa
Function curvilinear
curvilinear
variable
variable cost
cost
line
line within
within the
the
Relevant
relevant
relevant range.
range.
Total Cost

Range
Accountant’s Straight-Line
Approximation (constant
unit variable cost)

Activity
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 1-28

Fixed Costs and the Relevant

Range

The relevant range of activity pertains to fixed cost as

well as variable costs. For example, assume office space
is available at a rental rate of $30,000 per year in
increments of 1,000 square feet.

Fixed costs would increase in a

step fashion at a rate of $30,000 for
each additional 1,000 square feet.

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 1-29

Relevant Range: Graphic

90
Rent Cost in Thousands

The relevant range of

Relevant activity for a fixed cost
60
of Dollars

Range is the range of activity

over which the graph
of the cost is flat.
30

0
0 1,000 2,000 3,000
Rented Area (Square Feet)

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 Comparison of Cost 1-30

Classifications for Predicting

Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost Increase Variable cost per unit

and decrease in proportion remains constant.
to changes in the activity level.
Fixed Total fixed cost is not affected Fixed cost per unit decreases
by changes in the activity as the activity level rises and
level within the relevant range. increases as the activity level falls.

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 1-31

Quick Check 2
Which of the following costs would be variable
with respect to the number of ice cream cones
sold at a Baskin & Robbins? (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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 1-32

Quick Check 2a
Which of the following costs would be variable
with respect to the number of ice cream cones
sold at a Baskin & Robbins? (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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 1-33

Mixed Costs – Part 1

A
A mixed
mixed cost
cost contains
contains both
both variable
variable and
and fixed
fixed
elements.
elements. Consider
Consider the
the example
example of
of utility
utility cost.
cost.
Y
Total Utility Cost

ost
d c
x e
al mi
To t
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
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 1-34

Mixed Costs – Part 2

The total mixed cost line can be expressed
as an equation: Y = a + bX

Where: Y = The total mixed cost.

a = The total fixed cost (the
vertical intercept of the line).
Y b = The variable cost per unit of
activity (the slope of the line).
X = The level of activity.
Total Utility Cost

o st
d c
ix e
al m
Tot Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
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 1-35

Mixed Costs – An Example

If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?

Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
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 1-36

Learning Objective 5

Understand cost
classifications used in
making decisions:
differential costs, sunk
costs, and opportunity
costs.

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Education. All All rights
rights reserved.
reserved. Authorized
Authorized only
only for for instructor
instructor useuse in the
in the classroom. 
classroom.  No No reproduction
reproduction or
or further
further distribution
distribution permitted
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 1-37

Cost Classifications for Decision

Making

Decisions involve choosing between

alternatives. The goal of making decisions is
to identify those costs that are either
relevant or irrelevant to the decision.
To make decisions, it is essential to have a
grasp on three concepts: differential costs,
sunk costs, and opportunity costs.

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 1-38

Differential Costs

Differential costs (or incremental costs) are

the difference in cost between any two
alternatives.
A difference in revenue between two
alternatives is called differential revenue.
Both are always relevant to decisions.
Differential costs can be either fixed or
variable.

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 1-39

Sunk Costs

Sunk costs have already been incurred and

cannot be changed now or in the future.
These costs should be ignored when making
decisions.

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 1-40

Opportunity Cost
The potential benefit that is
given up when one alternative is
selected over another.

These costs are not usually found in

accounting records but must be
explicitly considered in every decision.

For students: What is the opportunity cost you

incur by attending class?
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 1-41

Quick Check 3
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the cost of the
train ticket relevant in this decision? In other
words, should the cost of the train ticket affect the
decision of whether you drive or take the train to
Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

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 1-42

Quick Check 3a
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the cost of
the train ticket relevant in this decision? In other
words, should the cost of the train ticket affect the
decision of whether you drive or take the train to
Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

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 1-43

Quick Check 4
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the annual
cost of licensing your car relevant in this
decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

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 1-44

Quick Check 4a
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the annual
cost of licensing your car relevant in this
decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

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 1-45

Quick Check 5
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.

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 1-46

Quick Check 5a
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.

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 1-47

Learning Objective 6

Prepare income
statements for a
merchandising company
using the traditional and
contribution formats.

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 1-48

The Traditional and Contribution

Formats
Comparison of the Contribution Income Statement
with the Traditional Income Statement

Traditional Format Contribution Format

Sales $ 100,000 Sales $ 100,000

Cost of goods sold 70,000 Variable expenses 60,000
Gross margin $ 30,000 Contribution margin $ 40,000
Selling & admin. expenses 20,000 Fixed expenses 30,000
Net operating income $ 10,000 Net operating income $ 10,000

Used primarily for Used primarily by

external reporting. management.

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 Uses of the Contribution
1-49

Format
The
The contribution
contribution income
income statement
statement format
format is
is used
used
as
as an
an internal
internal planning
planning andand decision-making
decision-making tool.
tool. We
We
will
will use
use this
this approach
approach for:
for:
1.Cost-volume-profit
1.Cost-volume-profit analysis
analysis (Chapter
(Chapter 5).
5).
2.Segmented
2.Segmented reporting
reporting of
of profit
profit data
data (Chapter
(Chapter 6).
6).
3.Budgeting
3.Budgeting (Chapter
(Chapter 8).
8).
4.Special
4.Special decisions
decisions such
such as
as pricing
pricing and
and make-or-buy
make-or-buy
analysis
analysis (Chapter
(Chapter 12).
12).

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 1-50

End of Chapter 1

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