Managerial Accounting and Cost

Concepts
Chapter 2

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright2012byTheMcGrawHillCompanies,Inc.Allrightsreserved.

2-2

Comparing Merchandising and

Manufacturing Activities
Merchandisers . . .
Buy finished
goods.
Sell finished
goods.
MegaLoMart

Manufacturers . . .
Buy raw materials.
Produce and sell
finished goods.

2-3

Learning Objective 1

Identify and give

examples of each of the
three basic
manufacturing cost
categories.

2-4

Classifications of Manufacturing Costs

Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

The Product

Manufacturing
Manufacturing
Overhead
Overhead

2-5

Direct Materials
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

2-6

Direct Labor
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

2-7

Manufacturing Overhead
Manufacturing costs that cannot be easily
traced directly to specific units produced.
Examples:
Examples: Indirect
Indirect materials
materials and
and indirect
indirect labor
labor

2-8

Nonmanufacturing Costs
Administrative
Costs

All executive,
organizational, and
clerical costs.

2-9

Learning Objective 2

Distinguish between
product costs and period
costs and give examples
of each.

2-10

Product Costs Versus Period Costs

Product costs include
direct materials, direct
labor, and
manufacturing
overhead.
Inventory

Cost of Good Sold

Period costs include all

selling costs and
administrative costs.

Expense

Sale

Balance
Sheet

Income
Statement

Income
Statement

2-11

Quick Check

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.

2-12

Quick Check

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.

2-13

Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct
Material

Direct
Labor

Prime
Cost

Manufacturing
Overhead

Conversion
Cost

2-14

Learning Objective 3

Understand cost
behavior patterns
including variable costs,
fixed costs, and mixed
costs.

2-15

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.

2-16

Variable Cost

Total Texting Bill

Your total texting bill is based on how

many texts you send.

Number of Texts Sent

2-17

Variable Cost Per Unit

Cost Per Text Sent

The cost per text sent is constant at

5 cents per text message.

Number of Texts Sent

2-18

The Activity Base (Cost Driver)

Machine
hours

Units
produced
A measure of what
causes the
incurrence of a
variable cost
Miles
driven

Labor
hours

2-19

Fixed Cost

Monthly Cell Phone

Contract Fee

Your monthly contract fee for your cell phone is

fixed for the number of monthly minutes in your
contract. The monthly contract fee does not
change based on the number of calls you make.

Number of Minutes Used

Within Monthly Plan

2-20

Fixed Cost Per Unit

Monthly Cell Phone

Contract Fee

Within the monthly contract allotment, the average fixed cost per
cell phone call made decreases as more calls are made.

Number of Minutes Used

Within Monthly Plan

2-21

Types of Fixed Costs

Committed

Discretionary

Long-term, cannot be
significantly reduced in
the short term.

May be altered in the

short-term by current
managerial decisions

Examples

Examples

Depreciation on Buildings
and Equipment and Real
Estate Taxes

Advertising and
Research and
Development

2-22

The Linearity Assumption and the Relevant

Range

Total Cost

Economists
Curvilinear Cost
Function
Relevant
Range

A
A straight
straight line
line
closely
closely
approximates
approximates aa
curvilinear
curvilinear
variable
variable cost
cost
line
line within
within the
the
relevant
relevant range.
range.

Accountants Straight-Line
Approximation (constant
unit variable cost)
Activity

2-23

Fixed Costs and the Relevant Range

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.

2-24

Rent Cost in Thousands

of Dollars

Fixed Costs and the Relevant Range

90
Relevant

60

Range

30
0

The
The relevant
relevant range
range
of
of activity
activity for
for aa fixed
fixed
cost
cost is
is the
the range
range of
of
activity
activity over
over which
which
the
the graph
graph of
of the
the
cost
cost is
is flat.
flat.

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

2-25

Cost Classifications for Predicting Cost

Behavior

2-26

Quick Check
Which of the following costs would be variable
with respect to the number of cones sold at a
Baskins & Robbins shop? (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.

2-27

Quick Check
Which of the following costs would be variable
with respect to the number of cones sold at a
Baskins & Robbins shop? (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.

2-28

The Analysis of Mixed Costs

Account Analysis

Engineering Approach

Scattergraph Plot
High-Low Method

Least-Square Regression Method

2-29

Account Analysis & Engineering

Estimates
Each
Each account
accountis
isclassified
classifiedas
aseither
either
variable
variableor
or fixed
fixedbased
based on
on the
theanalysts
analysts
knowledge
knowledgeof
ofhow
how the
theaccount
account behaves.
behaves.

Cost
Costestimates
estimatesare
arebased
basedon
onan
an
evaluation
evaluationof
ofproduction
productionmethods,
methods,
and
and material,
material, labor
labor and
andoverhead
overhead
requirements.
requirements.

2-30

The Scattergraph Method

Plot
Plot the
thedata
datapoints
pointson
onaa
graph
graph(total
(totalcost
cost vs.
vs. activity).
activity).

Total Cost in
1,000s of Dollars

Y
20

10

* *
* *

* ** *
**
X

0
1
2
3
4
Activity, 1,000s of Units Produced

2-31

Quick-and-Dirty Method

Draw
Draw aaline
linethrough
throughthe
thedata
datapoints
pointswith
withabout
aboutan
an
equal
equalnumbers
numbersof
ofpoints
points above
aboveand
and below
below the
the line.
line.

Total Cost in
1,000s of Dollars

Y
20

10

* ** *
**

* *
*
* Intercept
is the estimated

Intercept is the estimated

fixed
fixedcost
cost==$10,000
$10,000

0
1
2
3
4
Activity, 1,000s of Units Produced

2-32

Quick-and-Dirty
Method
The slope is the estimated variable cost per unit.

The slope is the estimated variable cost per unit.

Slope
Slope==Change
Changein
in cost
cost Change
Changein
inunits
units

Total Cost in
1,000s of Dollars

Y
20

10

* *
*
*Horizontal
Horizontal

distance
distanceis
is
the
thechange
changein
in
activity.
activity.

* ** *
**
Vertical
Verticaldistance
distanceis
is
the
thechange
changein
incost.
cost.

0
1
2
3
4
Activity, 1,000s of Units Produced

2-33

The High-Low Method

WiseCo recorded the following production activity and maintenance
costs for two months:

Using these two levels of activity, compute:

the variable cost per unit;
the fixed cost; and then
express the costs in equation form Y = a + bX.

2-34

The High-Low Method

cost in units
Variable cost per unit = Change Changein
in cost change
Change in units

2-35

The High-Low Method

Variable cost per unit = $2,400 3,000 units

= $0.80 per unit

2-36

The High-Low Method

Variable cost = $2,400 3,000 units = $0.80 per unit

Fixed cost = Total cost Total variable cost
Fixed cost = $9,800 ($0.80 per unit 8,000 units)
Fixed cost = $9,800 $6,400 = $3,400

2-37

The High-Low Method

Variable cost = $2,400 3,000 units = $0.80 per unit

Fixed cost = Total cost Total variable cost
Fixed cost = $9,800 ($0.80 per unit 8,000 units)
Fixed cost = $9,800 $6,400 = $3,400

Total cost = Fixed cost + Variable cost (Y = a + bX)

Y = $3,400 + $0.80X

2-38

Quick Check
Sales
Salessalaries
salariesand
andcommissions
commissionsare
are$10,000
$10,000when
when
80,000
80,000units
unitsare
aresold,
sold,and
and$14,000
$14,000when
when120,000
120,000units
units
are
aresold.
sold. Using
Usingthe
thehigh-low
high-lowmethod,
method,what
whatisisthe
thevariable
variable
portion
portionof
ofsales
salessalaries
salariesand
andcommission?
commission?
a.
a. $0.08
$0.08per
perunit
unit
Units
Cost
b.
$0.10
per
unit
b. $0.10 per unit
High level
120,000
$ 14,000
c.c. $0.12
per
unit
$0.12 per unit
Low level
80,000
10,000
d.
$0.125
per
unit
d. $0.125 per unit
Change

40,000

4,000

$4,000 40,000 units

= $0.10 per unit

2-39

Quick Check
Sales
Salessalaries
salariesand
andcommissions
commissionsare
are$10,000
$10,000when
when
80,000
80,000units
unitsare
aresold,
sold,and
and$14,000
$14,000when
when120,000
120,000units
units
are
aresold.
sold. Using
Usingthe
thehigh-low
high-lowmethod,
method,what
whatisisthe
thefixed
fixed
portion
portionof
ofsales
salessalaries
salariesand
andcommissions?
commissions?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.c. $10,000
$10,000
d.
d. $12,000
$12,000

2-40

Least-Squares Regression Method

Software can be used to fit a
regression line through the
data points.
The cost analysis objective is
the same: Y = a + bx

Least-squares
Least-squaresregression
regressionalso
alsoprovides
providesaa statistic,
statistic,
22
called
the
R
called the R ,,that
that is
is aameasure
measure of
of the
thegoodness
goodness
of
of fit
fitof
ofthe
theregression
regression line
lineto
tothe
thedata
data points.
points.

2-41

Mixed Costs

Total Utility Cost

al
t
o
T

d
e
x
mi

t
s
o
c
Variable
Cost per KW

Activity (Kilowatt Hours)

Fixed Monthly
Utility Charge

2-42

Mixed Costs An Example

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

2-43

Learning Objective 5
Prepare income
statements for a
merchandising company
using the traditional and
contribution formats.

2-44

The Traditional and Contribution Formats

Used primarily for

external reporting.

2-45

The Contribution Format

Sales Revenue
Less: Variable costs
Contribution margin
Less: Fixed costs
Net operating income

Total
$ 100,000
60,000
$ 40,000
30,000
$ 10,000

Unit
$ 50
30
$ 20

The contribution margin format emphasizes cost

behavior. Contribution margin covers fixed costs
and provides for income.

2-46

Learning Objective 6

Understand the differences

between direct and indirect
costs.

2-47

Assigning Costs to Cost Objects

Direct costs

Indirect costs

Costs that can be

easily and
conveniently traced
to a unit of product
or other cost object.

Costs that cannot

be easily and
conveniently traced
to a unit of product
or other cost object.

Examples: direct
material and direct
labor

Example:
manufacturing
overhead

2-48

Learning Objective 7
Understand cost
classifications used in
making decisions:
differential costs,
opportunity costs, and
sunk costs.

2-49

Cost Classifications for Decision Making

Every decision involves a choice
between at least two alternatives.
Only those costs and benefits
that differ between alternatives
are relevant in a decision. All
other costs and benefits can and
should be ignored as irrelevant.

2-50

Differential Cost and Revenue

Costs and revenues that differ
among alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.

Differential revenue is:

$2,000 $1,500 = $500

Differential cost is:

$300

2-51

Quick Check
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 dont 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.

2-52

Quick Check
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 dont 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.

2-53

Quick Check
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 dont 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.

2-54

Quick Check
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 dont 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.

2-55

Opportunity Cost
The potential benefit that is
given up when one alternative is
selected over another.
Example: If you were
not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for
one year is $15,000.

2-56

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.

Example: Suppose you had purchased gold for

$400 an ounce, but now it is selling for $250 an
ounce. Should you wait for the gold to reach $400 an
ounce before selling it? You may say, Yes even
though the $400 purchase is a sunk costs.

2-57

Sunk Costs
Sunk costs cannot be changed by any decision. They are
not differential costs and should be ignored when
making decisions.

Example: You bought an automobile that cost

$10,000 two years ago. The $10,000 cost is
sunk because whether you drive it, park it, trade
it, or sell it, you cannot change the $10,000 cost.

2-58

Quick Check
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.

2-59

Quick Check
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.