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
Copyright2014byTheMcGrawHillCompanies,Inc.Allrightsreserved.

2-2

Summary of the Types of Cost

Classifications
Financial
Reporting

Predicting Cost
Behavior

Assigning Costs
to Cost Objects

Making Business
Decisions

2-3

Learning Objective 1

Understand cost
classifications used for
assigning costs to cost
objects: direct costs and
indirect costs. and indirect
costs.

2-4

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.
Examples: direct
material and direct labor

Costs that cannot be

easily and conveniently
traced to a unit of product
or other cost object.
Example: manufacturing
overhead

Common costs
Indirect costs incurred to support a number
of cost objects. These costs cannot be
traced to any individual cost object.

2-5

Learning Objective 2

Identify and give

examples of each of the
three basic
manufacturing cost
categories.

2-6

Classifications of Manufacturing Costs

Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

The Product

Manufacturing
Manufacturing
Overhead
Overhead

2-7

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

2-8

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

2-9

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

Wages paid to employees

who are not directly
involved in production
work.
Examples: maintenance
workers, janitors, and
security guards.

2-10

Nonmanufacturing Costs
Selling
Costs

Administrative
Costs

Costs necessary to secure the

order and deliver the product.
Selling costs can be either
direct or indirect costs.

All executive, organizational,

and clerical costs.
Administrative costs can be
either direct or indirect costs.

2-11

Learning Objective 3

Understand cost
classifications used to
prepare financial
statements: product
costs and period costs.

2-12

Cost Classifications for Preparing

Financial Statements
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

2-13

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.

2-14

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.

2-15

Prime Costs and Conversion Costs

Manufacturing costs are often
classified as follows:
Direct
Material

Direct
Labor

Prime
Cost

Manufacturing
Overhead

Conversion
Cost

2-16

Learning Objective 4

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

2-17

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.

2-18

Variable Cost

Total Texting Bill

A cost that varies, in total, in direct proportion to

changes in the level of activity. Your total texting
bill may be based on how many texts you send.

Number of Texts Sent

2-19

Variable Cost Per Unit

Cost Per Text Sent

However, variable cost per unit is constant. The cost per

text sent may be constant at 5 cents per text message.

Number of Texts Sent

2-20

The Activity Base (Cost Driver)

Machine
hours

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

Labor
hours

2-21

Fixed Cost

Monthly Cell Phone

Contract Fee

A cost that remains constant, in total, regardless of

changes in the level of the activity. Your monthly contract
fee for your cell phone may be fixed for the number of
monthly minutes in your contract.

Number of Minutes Used

Within Monthly Plan

2-22

Fixed Cost Per Unit

Monthly Cell Phone

Contract Fee

However, if expressed on a per unit basis, the average fixed cost per
unit varies inversely with changes in activity. The average fixed cost
per cell phone call made decreases as more calls are made.

Number of Minutes Used

Within Monthly Plan

2-23

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

2-24

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

2-25

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.

2-26

Fixed Costs and the Relevant Range

Rent Cost in Thousands
of Dollars

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)

2-27

Cost Classifications for Predicting Cost

Behavior

2-28

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.

2-29

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.

2-30

Mixed 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

2-31

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

2-32

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

2-33

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 analysts
analysts 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.

2-34

Learning Objective 5

Analyze a mixed cost

using a scattergraph plot
and the high-low
method.

2-35

Scattergraph Plots An Example

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

2-36

The Scattergraph Method

Plot
Plot the
the data
data points
points on
on aa graph
graph (Total
(Total Cost
Cost YY dependent
dependent
variable
variable vs.
vs. Activity
Activity XX independent
independent variable).
variable).

Total Maintenance Cost

Scattergraph Method

$10,000
$9,500
$9,000
$8,500
$8,000
$7,500

$7,000
400

500

600

700

Hours of Maintenance

800

900

2-37

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

2-38

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

2-39

The High-Low Method An Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X

2-40

Quick Check
Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the variable portion of sales
salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit

2-41

Quick Check
Sales salaries and commissions are $10,000
when 80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the variable portion of sales
salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
$4,000 40,000 units
= $0.10 per unit

2-42

Quick Check
Sales
Sales salaries
salaries and
and commissions
commissions are
are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the fixed
fixed portion
portion of
of sales
sales salaries
salaries
and
and commissions?
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

2-43

Quick Check
Sales
Sales salaries
salaries and
and commissions
commissions are
are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the fixed
fixed portion
portion of
of sales
sales
salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000
Total cost = Total fixed cost +
Total variable cost
b.
b. $$ 4,000
4,000
$14,000 = Total fixed cost +
c.
c. $10,000
$10,000
($0.10 120,000 units)
d.
d. $12,000
$12,000
Total fixed cost

= $14,000 - $12,000

Total fixed cost

= $2,000

2-44

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.

2-45

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.

2-46

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.

2-47

Learning Objective 6
Prepare income
statements for a
merchandising company
using the traditional and
contribution formats.

2-48

The Traditional and Contribution

Formats

Used primarily for

external reporting.

Used primarily by
management.

2-49

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 8).
8).
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 12).
12).

2-50

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

2-51

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.

2-52

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

2-53

Opportunity Cost
The potential benefit that is
given up when one
alternative is selected over
another.

These
These costs
costs are
are not
not
usually
usually entered
entered into
into the
the
accounting
accounting records
records or
or an
an
organization,
organization, but
but must
must be
be
explicitly
explicitly considered
considered in
in all
all
decisions.
decisions.
What
What are
are the
the
opportunity
opportunity costs
costs you
you
incur
incur to
to attend
attend this
this class?
class?

2-54

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
$1,100 an ounce, but now it is selling for $950 an
ounce. Should you wait for the gold to reach $1,100
an ounce before selling it? You may say, Yes even
though the $1,100 purchase is a sunk costs.

2-55

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.

2-56

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.

2-57

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.

2-58

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.

2-59

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.

2-60

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.

2-61

End of Chapter 2