Module

Introduction to
Managerial Accounting
and Cost Concepts

Management Accounting
What is Management Accounting?
It is the process of identifying, measuring,
accumulating, analyzing, preparing,
interpreting, and communicating
information that managers use to
fulfill organizational objectives.

Differences Between Financial and

Managerial Accounting
Financial
Accounting

Managerial
Accounting

External persons who

make financial decisions

Managers who plan for

and control an organization

Historical perspective

Future emphasis

3. Verifiability
versus relevance

Emphasis on
verifiability

Emphasis on relevance
for planning and control

4. Precision versus
timeliness

Emphasis on
precision

Emphasis on
timeliness

5. Subject

Primary focus is on
the whole organization

Focuses on segments
of an organization

6. Requirements

Must follow GAAP

and prescribed formats

Need not follow GAAP

or any prescribed format

1. Users
2. Time focus

Planning and Controlling

What is decision making?
It is the purposeful choice from among
a set of alternative courses of action
designed to achieve some objective.
This is the core of the management process.

Work of Management
Planning

Directing and
Motivating

Controlling

Planning and Control Cycle

Formulating Long-and
Short-Term Plans
(Planning)

Comparing Actual
to
Planned Performance
(Controlling)

Decision
Making

Measuring
Performance
(Controlling)
6

Begin

Implementing
the Plans
(Directing and
Motivating)

Planning and Controlling

Corrections and Revisions

of Plans and Actions

The Management Process

Internal Accounting System

Budgets,
Special Reports

Planning
Increase
Productivity

Financial
Accounting
System

Controlling
Actions
Evaluations

Performance
Reports
7

Customer
surveys
Competitor
analysis
Advertising
impact
New items
report

Role of Budgets
A budget is a quantitative expression of a

plan of action and is an aid to

coordinating and implementing the plan.
Budgets are the chief devices for
compelling and disciplining management
planning.

Role of
Performance Reports
Performance reports formalize controls and
provide feedback by comparing results with
plans and by highlighting variances.
Variances are deviations from the plan.

Performance Report
Budgeted Actual
Variance
Amount Amount Amount
Revenues 25,000 19,000 6,000 U
Expenses 20,000 15,000 5,000 F
Net Income 5,000 4,000 1,000 U
F = Favorable
U = Unfavorable

10

Cost and Cost Terminology

Cost is a resource sacrificed or forgone to achieve

a specific objective.
An actual cost is the cost incurred (a historical cost)
as distinguished from budgeted costs.
A cost object is anything for which a separate
measurement of costs is desired.
11

Cost and Cost Terminology

Cost Object
Cost
Accumulation

Cost Object
Cost Object

Cost
Assignment

Tracing
Allocating
12

Direct Costs and Indirect Costs

Direct costs

Indirect costs

Costs that can be

Costs cannot be easily

easily and conveniently

traced to a unit of
product or other cost
objective.

Examples: direct

material and direct labor

13

and conveniently traced

to a unit of product or
other cost object.

Example:

manufacturing
overhead

Direct and Indirect Costs

Direct Costs
Example: Paper on which
Sports Illustrated magazine
is printed
Indirect Costs
Example: Lease cost for
Time-Warner building
housing the senior editors
of its magazine
14

COST
COSTOBJECT
OBJECT
Example:
Example:Sports
Sports
Illustrated
Illustratedmagazine
magazine

Direct and Indirect Costs

Example
Direct Costs:
Maintenance Department
$40,000
Personnel Department
$20,600
Assembly Department
$75,000
Finishing Department
$55,000
Assume that Maintenance Department costs are
allocated equally among the production departments.
How much is allocated to each department?
15

Direct and Indirect Costs Example

Maintenance
$40,000
Assembly
Direct Costs
$75,000

Finishing
Direct Costs
$55,000

$20,000

$20,000

Allocated
16

Comparing Merchandising and

Manufacturing Activities
Merchandisers . . .

Manufacturers . . .

Buy finished goods.

Sell finished goods.

Buy raw materials.

Produce and sell

finished goods.

MegaLoMart

17

Manufacturing Costs
Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

The Product

18

Manufacturing
Manufacturing
Overhead
Overhead

Direct Materials
Those 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

19

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

20

Manufacturing Overhead
Manufacturing costs that cannot be traced directly
to specific units produced.
Examples:
Examples: Indirect
Indirect labor
labor and
and indirect
indirect materials
materials
Wages paid to employees
who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.
21

Materials used to support

the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.

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

Direct
Direct
Labor
Labor

Prime
Cost

Manufacturing
Manufacturing
Overhead
Overhead

Conversion
Cost
22

Nonmanufacturing Costs
Marketing and selling costs . . .
Costs necessary to get the order and deliver the

product.

Administrative costs . . .
All executive, organizational, and clerical costs.

23

Quick Check
Which of the following costs would be
considered manufacturing overhead at Boeing?
(More than one answer may be correct.)
A. Depreciation on factory forklift trucks.
B. Sales commissions.
C. The cost of a flight recorder in a Boeing 767.
D. The wages of a production shift supervisor.

24

Product Costs Versus Period Costs

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

Cost of Good Sold

Period costs are not

included in product
costs. They are
expensed on the
income statement.
Expense

Sale

Balance
Sheet

Income
Statement
26

Income
Statement

Inventoriable Costs

Inventoriable costs (assets)

become cost of goods sold
after a sale takes place.
27

Period Costs

Period costs are all costs in the income

statement other than cost of goods sold.
Period costs are recorded as expenses of the
accounting period in which they are incurred.

28

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.

29

Balance Sheet
Manufacturer

Merchandiser

Current Assets

Current assets
Cash

Cash

Receivables

Receivables

Prepaid expenses
Merchandise inventory

Prepaid Expenses

31

Inventories
Raw Materials
Work in Process
Finished Goods

Balance Sheet
Merchandiser

Manufacturer

Current assets

Current Assets

Cash

Cash

Receivables

Receivables
Materials
waiting to
be processed.
Prepaid
Expenses

Prepaid expenses
Merchandise
Partially complete
inventory

products some
material, labor, or
overhead has been
added.

Inventories
Raw Materials
Work in Process
Finished Goods

Completed products
awaiting sale.
32

The Income Statement

Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for merchandisers.
Merchandising Company
Cost of goods sold:
Beg. merchandise
inventory
+ Purchases
Goods available
for sale
- Ending
merchandise
inventory
= Cost of goods
sold

$ 14,200
234,150
$ 248,350

(12,100)
$ 236,250

33

Manufacturing Cost Flows

Costs

Balance Sheet
Inventories

Material Purchases

Raw Materials

Direct Labor

Work in
Process

Manufacturing
Overhead

Selling and
Administrative

Finished
Goods

Period Costs
34

Income
Statement
Expenses

Cost of
Goods
Sold
Selling and
Administrative

Manufacturing Company
BALANCE SHEET
Inventoriable
Costs

Materials
Inventory

INCOME STATEMENT
Revenues

Finished
Goods
Inventory

when
sales
occur

deduct

Cost of
Goods Sold

Equals Gross Margin

deduct

Work in
Process
Inventory

Period
Costs
Equals Operating Income
35

Merchandising Company
BALANCE SHEET
Inventoriable
Costs

Merchandise
Purchases

INCOME STATEMENT
Revenues

Inventory

when
sales
occur

deduct

Cost of
Goods Sold

Equals Gross Margin

deduct

Period
Costs
Equals Operating Income
36

Many Meanings of Product Cost

A product cost is the sum of the costs
assigned to a product for a specific purpose.
1. Pricing and product emphasis decisions
2. Contracting with government agencies
3. Preparing financial statements for external
reporting under generally accepted
accounting principles
37

Quick Check
Which of the following transactions would
immediately result in an expense? (There may
be more than one correct answer.)
A. Work in process is completed.
B. Finished goods are sold.
C. Raw materials are placed into production.
D. Administrative salaries are accrued and
paid.

38

Inventory Flows
Beginning
Beginning
balance
balance
$$
$$

Available
Available
$$$$$
$$$$$

Additions
Additions
$$$
$$$

_ Withdrawals
Withdrawals
$$$
$$$

40

Available
Available
$$$$$
$$$$$

Ending
Ending
balance
balance
$$
$$

Quick Check
If your bank balance at the beginning of the
month was $1,000, you deposited $100 during
the month, and withdrew $300 during the
month, what would be the balance at the end of
the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.
41

Product Costs - A Closer Look

Raw Materials

Manufacturing
Costs

Work
In Process

Beginning raw
materials inventory

Beginning
Beginning inventory
inventory
is
is the
the inventory
inventory
carried
carried over
over from
from
the
the prior
prior period.
period.

43

Product Costs - A Closer Look

Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

Manufacturing
Costs

Work
In Process

Direct materials

As
Asitems
itemsare
areremoved
removed from
from raw
raw
materials
materialsinventory
inventoryand
and placed
placedinto
into
the
theproduction
productionprocess,
process, they
theyare
are
called
called direct
direct materials.
materials.
44

Quick Check
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used?
A.
$276,000
B.
$272,000
C.
$280,000
D.
$ 2,000
45

Product Costs - A Closer Look

Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

47

Work
In Process

Product Costs - A Closer Look

Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

48

Work
In Process

Conversion
Conversion
costs
costsare
arecosts
costs
incurred
incurredto
to
convert
convert the
the
direct
directmaterial
material
into
into aafinished
finished
product.
product.

Quick Check
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A.
$555,000
B.
$835,000
C.
$655,000
D.
Cannot be determined.
49

Product Costs - A Closer Look

Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

Work
In Process
Beginning work in
process inventory
+ Total manufacturing
costs
= Total work in
process for the
period

All
All manufacturing
manufacturing costs
costsincurred
incurred
during
during the
theperiod
period are
areadded
addedto
tothe
the
beginning
beginningbalance
balanceof
of work
workin
in
process.
process.
51

Product Costs - A Closer Look

Raw Materials
Beginning raw
materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production

Manufacturing
Costs

Work
In Process

Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

Beginning work in
process inventory
Total manufacturing
costs
Total work in
process for the
period
Ending work in
process inventory
Cost of goods
manufactured.

+
=

Costs
Costsassociated
associated with
with the
thegoods
goodsthat
that
are
arecompleted
completedduring
duringthe
the period
period are
are
transferred
transferredto
tofinished
finished goods
goods
inventory.
inventory.
52

Quick Check
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A.
$1,160,000
B.
$ 910,000
C.
$ 760,000
D.
Cannot be determined.
53

Product Costs - A Closer Look

55

Quick Check
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
56

Cost Drivers

What are cost drivers?

Output measures of resources and
activities are called cost drivers.

58

Cost Behavior

What is cost behavior?

It is how costs are related to, and affected
by, the activities of an organization.

59

Cost Drivers
Production Example
Example costs:
Example cost drivers:
Labor wages
Labor hours
Supervisory salaries
No. of people supervised
Maintenance wages
No. of mechanic hours
Depreciation
No. of machine hours
Energy
Kilowatt hours
60

Cost Drivers

How well the accountant does at identifying

the most appropriate cost drivers determines
how well managers understand cost behavior
and how well costs are controlled.

61

Cost Classifications for Predicting

Cost Behavior
How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
business
business activity.
activity.

Total
Totalvariable
variablecosts
costs

change
changewhen
whenactivity
activity
changes.
changes.

Total
Totalfixed
fixedcosts
costs
remain
remain unchanged
unchanged
when
whenactivity
activitychanges.
changes.

62

Comparison of
Variable and Fixed Costs
A variable cost is a cost that changes in direct
proportion to changes in the cost driver.
A fixed cost is not immediately affected
by changes in the cost driver.

63

Rules of Thumb

Think of fixed costs as a total.

Total fixed costs remain unchanged
regardless of changes in cost-driver activity.

64

Rules of Thumb

Think of variable costs on a per-unit basis.

The per-unit variable cost remains
unchanged regardless of changes
in the cost-driver activity.

65

Relevant Range
This rule of thumb holds true only within

reasonable limits.
The relevant range is the limit of costdriver activity within which a specific
relationship between costs and the cost
driver is valid.

66

Relevant Range

Fixed Costs

$16,000
$12,000
Relevant Range

$8,000

500

1,000 1,500 2,000

Volume in Units
67

$4,000
2,500

Total Variable Cost

Total Long Distance

Telephone Bill

Your total long distance telephone bill is

based on how many minutes you talk.

Minutes Talked
68

Variable Cost Per Unit

Per Minute
Telephone Charge

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Minutes Talked
69

Total Fixed Cost

Monthly Basic
Telephone Bill

Your monthly basic telephone bill probably

does not change when you make more local
calls.

Number of Local Calls

70

Fixed Cost Per Unit

Monthly Basic Telephone

Bill per Local Call

The average cost per local call decreases as

more local calls are made.

Number of Local Calls

71

Cost Classifications for Predicting

Cost Behavior
Behavior of Cost (within the relevant range)
Cost

In Total

Per Unit

Variable

Total variable cost changes

as activity level changes.

Variable cost per unit remains

the same over wide ranges
of activity.

Fixed

Total fixed cost remains

the same even when the
activity level changes.

Fixed cost per unit goes

down as activity level goes up.

72

Cost Behavior
Examples of normally variable costs
Merchandisers

Service Organizations

Cost of Goods Sold

Supplies and travel

Manufacturers

Merchandisers and
Manufacturers

Direct Material, Direct

Labor, and Variable
Manufacturing Overhead

Sales commissions and

shipping costs

Examples of normally fixed costs

Merchandisers, manufacturers, and
service organizations
Real estate taxes, Insurance, Sales salaries
Depreciation, Advertising
73

The Activity Base

Units
produced

Machine
hours

A measure of the event

causing the incurrence of a
variable cost a cost driver

Miles
driven

Labor
hours
74

Types of Fixed Costs

Fixed Costs
Committed

Discretionary

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

May be altered in the

short-term by current
managerial decisions

Examples

Examples

Depreciation on
Buildings and
Equipment

Advertising and
Research and
Development
75

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.

76

Quick Check
Which of the following costs would be variable
with respect to the number of people who buy a
ticket for a show at a movie theater? (There
may be more than one correct answer.)
A. The cost of renting the film.
B. Royalties on ticket sales.
C. Wage and salary costs of theater
employees.
D. The cost of cleaning up after the show.
78

Fixed Costs and Relevant Range

Example: Office space
is available at a rental
rate of $30,000 per year
in increments of 1,000
square feet. As the
business grows more
space is rented,
increasing the total cost.
Continue
80

Rent Cost in
Thousands of Dollars

Fixed Costs and Relevant Range

90
Relevant

60

Range

30
00

Total cost doesnt

change for a wide
range of activity,
and then jumps to a
new higher cost for
the next higher
range of activity.

1,000
2,000
3,000
Rented Area (Square Feet)
81

Quick Check
Which of the following statements about cost
behavior are true?
a. Fixed costs per unit vary with the level of
activity.
b. Variable costs per unit are constant within
the relevant range.
c. Total fixed costs are constant within the
relevant range.
d. Total variable costs are constant within the
relevant range.
82

Cost Behavior Patterns Example

Bicycles by the Sea buys a handlebar

at $52 for each of its bicycles.
What is the total handlebar cost when
1,000 bicycles are assembled?

84

Cost Behavior Patterns Example

1,000 units $52 = $52,000

What is the total handlebar cost
when 3,500 bicycles are assembled?
3,500 units $52 = $182,000

85

Cost Behavior Patterns Example

Bicycles by the Sea incurred $94,500 in

a given year for the leasing of its plant.
This is an example of fixed costs with
respect to the number of bicycles assembled.

86

Cost Behavior Patterns Example

What is the leasing (fixed) cost per bicycle

when Bicycles assembles 1,000 bicycles?
$94,500 1,000 = $94.50
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 3,500 bicycles?
$94,500 3,500 = $27
87

Cost Drivers

The cost driver of variable costs is the level

of activity or volume whose change causes
the (variable) costs to change proportionately.
The number of bicycles assembled is a
cost driver of the cost of handlebars.

88

Relevant Range Example

Assume that fixed (leasing) costs are $94,500

for a year and that they remain the same for a
certain volume range (1,000 to 5,000 bicycles).
1,000 to 5,000 bicycles is the relevant range.

89

Relevant Range Example

$94,500

90

Relationships of Types of Costs

Direct

Variable

Fixed

Indirect
91

Interpret unit costs cautiously.

92

Total Costs and Unit Costs Example

What is the unit cost (leasing and handlebars)

when Bicycles assembles 1,000 bicycles?
Total fixed cost $94,500
+ Total variable cost $52,000 = $146,500
$146,500 1,000 = $146.50

93

Total Costs and Unit Costs

Example
$146,500
52
$
+
0
0
$94,5

$94,500

94

Use Unit Costs Cautiously

Assume that Bicycles management uses a
unit cost of $146.50 (leasing and wheels).
Management is budgeting costs for
different levels of production.
What is their budgeted cost for an
estimated production of 600 bicycles?
600 $146.50 = $87,900
95

Use Unit Costs Cautiously

What is their budgeted cost for an estimated
production of 3,500 bicycles?
3,500 $146.50 = $512,750
What should the budgeted cost be for an
estimated production of 600 bicycles?

96

Use Unit Costs Cautiously

Total fixed cost
$ 94,500
Total variable cost ($52 600)
31,200
Total
$125,700
$125,700 600 = $209.50
Using a cost of $146.50 per unit would
underestimate actual total costs if output
is below 1,000 units.
97

Use Unit Costs Cautiously

What should the budgeted cost be for an
estimated production of 3,500 bicycles?
Total fixed cost
$ 94,500
Total variable cost (52 3,500) 182,000
Total
$276,500
$276,500 3,500 = $79.00

98

Prime Costs

Direct
Materials

Direct
Labor

99

Prime
Costs

Conversion Costs

Direct
Labor

Manufacturing
Overhead

Indirect
Labor

Indirect
Materials
100

Other

Conversion
Costs

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.

101

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.

102