Chapter 2 Managerial Accounting and Cost Concepts

*In managerial accounting, the word cost is used in many different ways,
depending on managements needs.
- Different costs for different purposes.

Assigning costs to cost objects:

Cost Object anything for which cost data are desired
- Products, customers, jobs, departments, etc.
- Cost are either Direct or Indirect
o Direct cost a cost that can be easily and conveniently traced to a
specified cost object.
Line workers on a specific product
o Indirect cost cost that cannot be easily and conveniently traced to a
specific cost object
Manager of all line workers on many products
Type of Indirect cost is a Common Cost cost that is incurred to
support a number of cost objects by cannot be traced to them
individually

Accounting for costs in manufacturing companies:

Manufacturing Costs most manufacturing companies separate their manufacturing
costs into 2 direct costs (direct materials, direct labor) and 1 indirect cost
(manufacturing overhead).
o Raw materials the materials that go into the final product
can be either direct or indirect

- Direct Materials those materials that become an integral part of the finished
product and whose costs can be conveniently traced to the finished product
- Direct Labor labor costs that can be easily traced to individual units of product
- Manufacturing Overhead all manufacturing costs except direct materials and
direct labor
o Indirect materials materials such as glue or paint where it isnt worth the
effort to trace the costs of relatively insignificant materials to the product
o Indirect labor labor costs that cannot be physically traced to particular
products (line supervisors, janitors, security guards)
o Maintenance and repairs on manufacturing equipment, utilities (PGE,
SMUD), property taxes and depreciation on manufacturing facilities

Nonmanufacturing Costs (or Selling, General, and administrative SG&A) 2

categories
- Selling costs all costs that are incurred to secure customer orders and get the
finished product to the customer
o Advertising, shipping, sales travel, sales commissions, sales salaries, cost
of finished goods warehouses
- Administration costs all costs associated with the general management of a
company, rather than with manufacturing or selling
o Executive salaries, accounting dept, public relations, human resources

Preparing Financial Statements:

Product costs all costs involved in acquiring or making a product
- In manufacturing includes DM, DL amd MOH
- Product costs attach to the units of product as the goods are purchased or
manufactured and remain attached as the goods go into inventory awaiting sale
o Because product costs are assigned to inventory, they are known as
inventoriable costs

Period costs all costs that are not product costs

- All selling and administrative expenses
o Sales commissions, advertising, executive salaries, admin office rent

Prime cost sum of direct materials and direct labor

Conversion cost sum of direct labor and manufacturing overhead
- Conversion costs are incurred to convert materials into the finished product

Predicting cost behavior in response to changes in activity:

Cost behavior how a cost reacts to changes in the level of activity
- As the activity level rises or falls, a particular cost may rise or fall as well or
may remain constant

Cost Structure proportion of each type of cost in an organization

Variable cost cost that varies in total, in direct proportion to the changes in the
level of activity
- Activity base/cost driver measure of whatever causes the variable cost, such
as:
o Direct labor hours
o Machine-hours, units produced, units sold
Fixed cost cost that remains constant, in total, regardless of the changes in the
level of activity
- Committed fixed costs organizational investments with a multiyear planning
horizon that cant be significantly reduced even for short periods of time without
making fundamental changes
- Discretionary fixed costs arise from annual decisions by management; can be
cut for short periods of time with minimal damage to the long-run goals of the
organization
- Relevant range range of activity within which the assumption of cost behaviors
remains valid

Variable Cost Fixed Cost Fixed Costs &

relevant range

Mixed Costs

Traditional Format vs Contribution Format Income Statement

Differential cost/incremental cost difference in cost between any two alternative
business decisions

Differential revenue difference in revenues (sales) between any two alternatives

Opportunity cost potential benefit that is given up when one alternative is selected
over another

Sunk Cost cost that has already been incurred and cannot be changed by any
decision made now or in the future
- Sunk costs should be ignored when in current decision making alternatives