MANAGERIAL ACCOUNTING

AND COST CONCEPTS

Group 1

References:
1. Introduction to Managerial Accounting 11th edition (Brewer, Garrison, Noreen)
2. Principles of Managerial Accounting 11th edition (Reeve, Warren, Duchac)
What is a COST?

■ Refers to the payment of cash or the

commitment to pay cash in the future for
the purpose of generating revenues.
■ In managerial accounting, cost are
classified according to the decision-making
needs of management.
 Cost Classification:
Assigning Cost to Cost Objects

■ Direct costs – ■ Indirect costs –

refers to the costs refers to the costs
that can be easily that cannot be easily
and conveniently and conveniently
traced to a unit of traced to a unit of
product or other product or other cost
cost object. object.
 Example of Direct Cost
■ Direct costs – refers to the costs that can be
easily and conveniently traced to a unit of
product or other cost object.

The cost of the wood (materials) used by a guitar

manufacturing is a direct cost of the guitar.
 Example of Indirect Cost
■ Indirect costs – refers to the costs that
cannot be easily and conveniently traced to
a unit of product or other cost object.

The salaries of the Production Supervisor of a guitar

manufacturing are indirect cost of producing a guitar.
While the production supervisor contribute to the production
of a guitar, the salaries paid cannot be identified with or
traced to any individual guitar.
 Cost Classification for
Manufacturing Companies
1.Direct Materials Cost
2.Direct Labor Cost
3.Factory Overhead Cost
 Direct Materials Cost
■ Manufactured products begin with raw
materials that are converted into finished
products.
■ To classify as a direct material cost, the cost
must be BOTH of the following:
– An integral part of the finished product.
– A significant portion of the total cost of
the product.
 Direct Labor Cost
■ For manufacturing companies, they use
employees to convert materials into finished
product.
■ To classify as a direct labor cost, the cost must
meet BOTH of the following:
– An integral part of the finished product.
– A significant portion of the total cost of the
product.
Ex. Wages of the employees who cut each
guitar out of raw lumber and assemble it.
 Factory Overhead Cost
■ Refers to the cost other than direct
materials cost and direct labor cost
that are incurred in the
manufacturing process which are
combined and classified.
■ Also called as manufacturing
overhead or factory burden.
■ Indirect costs of the product.
Example: Electricity to run the
machines, Property taxes and
insurance on factory buildings.
Prime Cost and Conversion Cost
■ Prime Costs – consists of direct
materials and direct labor costs.
■ Conversion Costs – consists of direct
labor and factory overhead costs.
Prime Cost and Conversion Cost
 Product Costs and
Period Costs
■ Product Costs – consist of manufacturing costs
(direct materials, direct labor and factory
overhead).
■ Period Costs – consist of selling and
administrative expenses.
– Selling expenses : incurred in marketing the
product and delivering the product to
customers.
– Administrative expenses: incurred in
managing the company and are NOT directly
to the manufacturing or selling functions.
Product Costs and Period Costs
Cost Classification Diagram
 Cost Classification for
Preparing Financial Statement
■ Merchandising and manufacturing firms,
both prepare financial statement for
creditors, stockholder and others to show
the financial condition of the firm over some
period of time.
■ The production process give rise to many
costs that do not exist in a merchandising
company and some how these cost must be
accounted for the manufacturing company’s
financial statement.
 The Balance Sheet
Merchandiser Manufacturer
Current Asset Current Asset
– Cash – Cash
– Receivables – Receivables
– Prepaid Expense – Prepaid Expense
– Merchandise inventory – Inventories
■ Raw Material
■ Work in Process
■ Finished Goods
 The Income Statement

Merchandising Company Manufacturing Company

Cost of goods sold: Cost of goods sold:

Beg. Merchandise Beg. Merchandise
$ 15,000 $ 15,000
inv. inv.
+ Purchases 250,000 + Cost of goods
250,000
Goods available for manufactured
$ 265,000
sale Goods available for
$ 265,000
- Ending
(13,500)
sale
merchandise inv. - Ending
= Cost of goods sold $ 251,500 (13,500)
merchandise inv.
= Cost of goods sold $ 251,500
 The Income Statement

Cost of Good Sold Equation Cost of Good Sold Equation

in Merchandising Company: in Manufacturing Company:

Cost of good sold = Beg. Cost of goods sold =

merchandising inv. + Beg. Finished goods
Purchases – Ending inv. + Cost of goods
merchandising inv. manufactured – Ending
finished goods
inventory
 Cost of Goods
• Cost of Goods Manufactured is derived from
the schedule of cost of good manufactured

• Schedule of Cost of Goods Manufactured

• Contains three elements
• Direct Material
• Direct Labor
• Manufacturing Overhead
• Calculates the manufacturing costs associated with
goods that were finished during the period.
 Product Cost Flow
Raw Materials Manufacturing Work in
Cost Process
Beg. raw materials
Direct materials
inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
- Ending raw
materials
inventory
= Raw materials
used in
production
 Product Cost Flow
Raw Materials Manufacturing Work in Process
Cost
Direct materials
Beg. raw materials Beg. Work in
+ Direct labor
inventory process inventory
+ Mfg. overhead
= Total
+ Raw materials
manufacturing
purchased
costs
= Raw materials
available for use in
production
- Ending raw
materials inventory
= Raw materials
used in production
 Product Cost Flow
Raw Materials Manufacturing Cost Work in Process

Direct materials Beg. Work in process

+ Direct labor inventory

Beg. raw materials + Total

inventory
+ Mfg. overhead manufacturin
g costs
+ Raw materials = Total manufacturing = Total work in process
purchased costs for the period

= Raw materials
available for use in
production
- Ending raw materials
inventory
= Raw materials used in
production
 Product Cost Flow
Raw Materials Manufacturing Work in Process
Cost
Direct materials Beg. Work in
Beg. raw materials process inventory
+ Direct labor
inventory + Total
+ Mfg. overhead manufacturing costs
= Total work in
+ Raw materials = Total
process for the
purchased manufacturing costs
period
= Raw materials
- Ending work in
available for use in
process inventory
production
- Ending raw = Cost of goods
materials inventory manufactured
= Raw materials
used in production
 Product Cost Flow
Work in Finished Goods
Process
Beg. Work in process Beg. Finished goods
inventory inventory
+ Manufactured costs for + Cost of goods
the period manufactured
= Total work in process for = Cost of goods available
the period for sale
- Ending work in process - Ending finished goods
inventory inventory

= Cost of goods Cost of goods

manufactured sold
 Cost Classification for
Predicting Cost Behavior
• How a cost will react to
changes in the level of activity
within the relevant range
• Total Variable Cost change
when activity change.
• Total Fixed Cost remain
unchanged when activity
changes.
 Cost Classification for
Predicting Cost Behavior
Behavior of Cost (Within the relevant range)
Cost In Total Per Unit

Variable Total variable cost Variable cost per unit

changes as activity remains the same over
level changes. wide ranges of activity
Fixed Total fixed cost remains Average fixed cost per
the same even when unit goes down as
the activity level activity level goes up.
changes
 Cost Classification for Predicting
Cost Behavior: FIXED COST
• Fixed costs are those which do not change with the level of activity within
the relevant range.
• These costs will incur even if no units are produced. For example rent
expense, straight-line depreciation expense, etc.
• Fixed cost per unit decreases with increase in production.
 Cost Classification for Predicting
Cost Behavior: VARIABLE COST
• Variable costs change in direct proportion to the level of production. This
means that total variable cost increase when more units are produced
and decreases when less units are produced. Although variable in total,
these costs are constant per unit.
 The Analysis of Mixed Costs
A Mixed cost (Semi-variable cost or semi-fixed
cost) - A cost that contains both variable cost and
fixed cost element.

■ Variable cost – Costs that vary with output.

■ Fixed cost – Costs that are independent of

output.
The Analysis of Mixed Costs
The Analysis of Mixed Costs
 The Analysis of Mixed Costs

Total quantity of units produced x Variable cost

per unit = Total variable cost
Formula is Y = (a*x) + b
Y - Total Cost
A - Variable cost/unit
X - No. of units
B - Fixed cost
 The Analysis of Mixed Costs

Example: The Telecommunication

Company charges the Company
ABC, a manufacturing company, a
flat monthly rate of $300 dollars
per month for basic electricity
service. Then they charge $1.50 per
kilowatt hour (kwh).

If the Company ABC uses

50,000 kwhs of electricity in a
particular month, then its electric
bill would be?
 The Analysis of Mixed Costs

Y = (a*x) + b
Total Mixed Cost = (Variable cost per unit * number of units) +
fixed cost
= ($1.50 * 50,000kwhs) + $300
= $75,000 + $300
Total Mixed Cost = $75,300

■ Variable Cost - usage of electricity, kwhs

■ Fixed Cost - monthly flat rate
The Analysis of Mixed Costs
The Analysis of Mixed Costs
 Types of Income Statement
1. Traditional Format
2. Contribution Formal
 Traditional Format
Income Statement
■ A traditional income statement is
prepared under a traditional absorption
costing (full costing) system and is used
by both external parties and internal
management. As this statement fulfills
the requirements of external parties to
great extent, companies are required to
follow applicable accounting standards
such as generally accepted accounting
principles (GAAP) or international
accounting standards (IAS).
 Contribution Income
Statement
■ A contribution margin income statement,
on the other hand, is a purely management
oriented format of presenting revenues and
expenses that helps in various revenues
and expense related decision making
processes. Companies are not required to
present such statements to any external
party, so there is no need to follow GAAP or
IAS.
Traditional and Contribution
Format Financial Statement
 Problem Solving
Example:
The Company XYZ is a single product company. The following data is
available for the month of March 2017.
■ Sale price per unit: $30
■ Number of units manufactured and sold during the month: 2,000
■ Variable manufacturing cost per unit: $12
■ Variable selling and administrative cost per unit: $4
■ Fixed manufacturing cost per month: $6,000
■ Fixed marketing and administrative cost per month: $2,000

Company does not maintain finished goods and work in process inventory.
 Traditional Format
Income Statement
Sales (2,000 x $30) $ 60,000
Less: Cost of Goods Sold (2,000 x $15*) 30,000
Gross Profit 30,000

Less Marketing and Administrative exp.

Variable ( 2,000 x $4) $ 8,000
Fixed $ 2,000 $ 10,000

Net Operating Income $ 20,000

*12 + ($6,000/2,000)
 Contribution Margin Format
Income Statement
Sales (2,000 x $30) $ 60,000
Less: Variable Cost of Goods Sold (2,000 x $12) 24,000
Gross Margin 36,000

Less Marketing and Administrative exp.

( 2,000 x $4) 8,000
Contribution Margin $ 28,000

Less fixed/period expenses:

Manufacturing $ 6,000
Marketing and administrative $ 2,000 $ 8,000

Net Operating Income $ 20,000

 Cost Classification for
Decision Making
■ Decision-making involves a choice between
at least two alternatives.
■ Costs and Benefits that differ between
alternatives are relevant in a decision-
making process.
 Cost Classification for
Decision Making
■ Opportunity Costs – refers
to the potential benefit that
is given up when one
alternative is selected over
another.
■ Sunk Costs – refers to
already been incurred and
cannot be changed now or
in the future. It must be
ignored when making
decisions.
 Cost Classification for Decision
Making: OPPORTUNITY COST
■ Examples:
– Going on a vacation now or
SAVE and INVEST the money
for your future.
– If you were not attending
college, you could be earning
Php 300,000 per year. Your
opportunity cost of attending
college for one year is Php
300,000.
 Cost Classification for
Decision Making: SUNK COST
■ Examples:
– Buying a car that cost Php 1.5 Million, two
years ago. The Php 1.5 Million cost is sunk
because whether you drive, park, trade or
sell it, you cannot change the cost.
– Marketing study. A company spends
Php5,000,000 on a marketing study to see if
its new auburn widget will succeed in the
marketplace. The study concludes that the
widget will not be profitable. At this point, the
Php 5,000,000 is a sunk cost. The company
should not continue with further investments
in the widget project, despite the size of the
earlier investment.