Managerial Accounting and

Cost Concepts
Chapter 01

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
McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Classifications of Manufacturing
Costs
Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

Manufacturing
Manufacturing
Overhead
Overhead

The Product

1-2

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

1-3

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

1-4

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

1-5

Nonmanufacturing Costs
Administrative
Costs

All executive,
organizational, and
clerical costs.

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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
1-7

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

Direct
Labor

Prime
Cost

Manufacturing
Overhead

Conversion
Cost
1-8

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

1-9

Variable Cost

Total Texting Bill

Your total texting bill is based on how

many texts you send.

Number of Texts Sent

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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

1-11

The Activity Base (Cost Driver)

Machinehours

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

Laborhours
1-12

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

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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
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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
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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
1-16

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.

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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)
1-18

Cost Classifications for Predicting Cost

Behavior

1-19

Mixed Costs
(also called semivariable costs)
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.
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
1-20

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
1-21

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?

1-22

Analysis of Mixed Costs

Account Analysis and the Engineering Approach
In
In account
account analysis
analysis,, each
each account
account is
is
classified
classified as
as either
either variable
variable or
or fixed
fixed based
based
on
on the
the analyst
analysts
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
engineers
engineers evaluation
evaluation of
of production
production
methods,
methods, and
and material,
material, labor,
labor, and
and
overhead
overhead requirements.
requirements.
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Scattergraph Plots An Example

Assume the following hours of maintenance work and the total maintenance costs for six months.

1-24

The Scattergraph Method

Plot
Plot the
the data
data points
points on
on aa graph
graph
(Total
(Total Cost
Cost Y
Y vs.
vs. Activity
Activity X).
X).
Total Maintenance Cost

X
Hours of Maintenance

1-25

The High-Low Method An

Example
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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The High-Low Method An Example

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

1-27

The High-Low Method An

Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
1-28

Least-Squares Regression Method

A method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between the X and Y variables.
This method uses all of the
data points to estimate
the fixed and variable
cost components of a
mixed cost. The goal of this method is
to fit a straight line to the
data that minimizes the
sum of the squared errors.

1-29

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 regression also provides a statistic,

called the R22, which is a measure of the goodness
of fit of the regression line to the data points.
1-30

Comparing Results From

the Two Methods
The
The two
two methods
methods just
just discussed
discussed provide
provide
different
different estimates
estimates of
of the
the fixed
fixed and
and variable
variable cost
cost
components
components of
of aa mixed
mixed cost.
cost.
This
This is
is to
to be
be expected
expected because
because each
each method
method
uses
uses differing
differing amounts
amounts of
of the
the data
data points
points to
to
provide
provide estimates.
estimates.
Least-squares
Least-squares regression
regression provides
provides the
the most
most
accurate
accurate estimate
estimate because
because itit uses
uses all
all the
the data
data
points.
points.
1-31

The Traditional and Contribution

Formats

Used primarily for

external reporting.
1-32

Uses of the Contribution Format

The
The contribution
contribution income
income statement
statement format
format is
is used
used
as
as an
an internal
internal planning
planning and
and 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.Budgeting
2.Budgeting (Chapter
(Chapter 7).
7).
3.Segmented
3.Segmented reporting
reporting of
of profit
profit data
data (Chapter
(Chapter 6).
6).
4.Special
4.Special decisions
decisions such
such as
as pricing
pricing and
and make-ormake-orbuy
buy analysis
analysis (Chapter
(Chapter 10).
10).
1-33

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

1-34

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.

1-35

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

1-36

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.
1-37

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 cost.
1-38

Summary of the Types of Cost

Classifications
Financial
Reporting

Predicting Cost
Behavior

Assigning Costs
to Cost Objects

Making Business
Decisions
1-39

End of Chapter 01

1-40