Managerial Accounting and Cost

Concepts
CHAPTER 1

Introduction to
Managerial Accounting
Ninth edition

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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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 1-5

Assigning Costs to Cost 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
Materials

Direct
Labor

Manufacturing
Overhead

HKEJ, 02 Jan 2024

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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: A radio installed in an 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: Wages paid to automobile assembly

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 Includes
indirect materials that indirect labor costs
cannot be easily or that cannot be easily
conveniently traced or conveniently traced
to specific units of to specific units of
product. product.
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 1-11

Manufacturing Overhead –
Examples
Examples of manufacturing overhead:
• Depreciation of manufacturing
equipment
• Utility costs
• Property taxes
• Insurance premiums incurred to
operate a manufacturing facility
Only those indirect costs
associated with operating the factory
are included in manufacturing overhead.
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 1-12

Prime Costs and Conversion 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 can be either direct
or indirect costs. or 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 costs “attach” to a unit of product

as it is purchased or manufactured
and they stay attached to each
unit of product as long as
the unit remains in inventory awaiting sale.

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 1-16

Manufacturing Product Costs

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

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement

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 1-19

Learning Objective 4

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

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 1-20

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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 1-21

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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 1-22

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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 1-23

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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 1-24

Types of Fixed Costs

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

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 1-25

The Linearity Assumption and the

Relevant Range

Economist’s A straight line

closely
Curvilinear Cost approximates a
Function curvilinear
variable cost
line within the
Relevant
relevant range.
Total Cost

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

Activity
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 1-26

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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 1-27

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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 1-28

Comparison of Cost 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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 1-29

Mixed Costs – Part 1

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

os t
d c
ixe
al m
Tot
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
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 1-30

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).
Total Utility Cost

X = The level of activity.

os t
d c
ixe
al m
Tot
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
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 1-31

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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 1-32

Analysis of Mixed Costs

Account Analysis and the Engineering Approach

In
In account
account analysis,
analysis, each
each account
account isis
classified
classified as
as either
either variable
variable or
or fixed
fixed based
based
on
on the
the analyst’s
analyst’s knowledge
knowledge of of how
how
the
the account
account behaves.
behaves.

The
The engineering
engineering approach
approach classifies
classifies
costs
costs based
based upon
upon an
an industrial
industrial
engineer’s
engineer’s evaluation
evaluation of
of production
production
methods,
methods, and
and material,
material, labor,
labor, and
and
overhead
overhead requirements.
requirements.

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 1-33

The High-Low Method – An Example

Total Costs = Total Fixed Cost + Variable Cost (Qty)
The variable cost
per hour of
maintenance is
equal to the change
in cost divided by
the change in hours.

$2,400
= $6.00/hour
400
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 1-34

The High-Low Method – An Example

Y = a + bX
$9,800 = FC + VC(850)
$7,400 = FC + VC(450)

Total Fixed Cost = Total Cost – Total Variable Cost

Total Fixed Cost = $9,800 – ($6/hour × 850 hours)
Total Fixed Cost = $9,800 – $5,100
Total Fixed Cost = $4,700
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 1-35

The High-Low Method – An Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
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 1-36

Learning Objective 5

Understand cost
classifications used in
making decisions: relevant
costs and irrelevant costs.

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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 the concepts of differential costs
and revenues, opportunity costs, and sunk
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

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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 1-40

Sunk Costs

Sunk costs have

already been incurred and cannot be
changed now or in the future.
These irrelevant costs
should be ignored
when making decisions.

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 1-41

Learning Objective 6

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

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 1-42

Traditional and Contribution Formats

Used primarily for Used primarily by

external reporting. management.

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 1-43

Uses of the Contribution Format

The contribution income statement format
is used as an internal planning and
decision-making tool. We will use this
approach (in future chapters) for:
1. Cost-volume-profit analysis (Chapter 6)
2. Segmented reporting of profit data
(Chapter 7)
3. Budgeting (Chapter 8)
4. Special decisions such as pricing and
make-or-buy analysis (Chapter 11)

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 1-44

End of Chapter 1

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 1-45

Concept 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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 1-46

Concept 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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 1-47

Concept 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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 1-48

Concept 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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 1-49

Concept 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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 1-50

Concept 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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 1-51

Concept 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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 1-52

Concept 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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 1-53

Concept 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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 1-54

Concept 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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