Managerial Accounting and Cost

Concepts
Chapter 2
 2-2

Summary of the Types of Cost

Classifications

Financial Predicting Cost

Reportin Behavior
g

Assigning Costs Making Business

to Cost Objects Decisions
 2-3

Learning Objective 1

Understand cost
classifications used for
assigning costs to cost
objects: direct costs and
indirect costs.
 2-4

Assigning Costs to Cost Objects

Direct costs Indirect costs
• Costs that can be • Costs that cannot be
easily and conveniently easily and conveniently
traced to a unit of product traced to a unit of product
or other cost object. or other cost object.
• Examples: direct • Example: manufacturing
material and direct labor 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 Manufacturing

Materia Labor Overhead
ls

The Product
 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
 2-10

Nonmanufacturing Costs

Administrative
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 Period s include all
direct materials, direct cost costs and
labor, and selling ative costs.
manufacturing administr
overhead.
Inventory Cost of Good Sold Expense
Exp
Sale

Balance Income Income

Sheet Inco
Statement
Statement State
 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
D rect Direct
D rec Manufacturing
Manu actur ng
Material
Ma eria Labor
Labor Overhead
Overhead

Prime Conversion
Cost 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
A cost that varies, in total, in direct proportion to
changes in the level of activity. Your total
bill may be based on texting
how many texts you send.
Total Texting Bill

Number of Texts Sent

 2-19

Variable Cost Per Unit

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

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

Cost Per Text Sent

Number of Texts Sent

 2-20

The Activity Base (Cost Driver)

Units Machine
produc hours
ed
AA
mmeaseasur
t ure
i e of
rrof wwhathat
i
ccause ausess
hehe
Miles ncncuur Labor
drive enceence ofof hours
n aa vvarar
ablablee
 2-21

Fixed Cost
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.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

Within Monthly Plan
 2-22

Fixed Cost Per Unit

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.

Monthly Cell Phone

Contract Fee

Number of Minutes Used

Within Monthly Plan
 2-23

Types of Fixed Costs

Committed
Comm e Discretionar
D scret ona yr
Long-
Long-ter m, cann
e rm cannot be
o be May be a yered n
significantly
sign can y reduced
reduced in
n May
sho rtbe
shor e altered
mby
term cuinhethe
bycurrent
the eshort
shortterm.
erm manageria deci rren
managerial decisi ons
s ions

Examples Example
Examples
Dep Depr
ecia reciation
on on Buond ngs s
Advertising
Adverti
Advert sing and
and
Buildings and Equipment
and Equ pmen and Rea Resear
Resear
Research
chand
and
and Real
Esta Estate
e Taxes Taxes Development
Devel
Deve opmen
 2-24

The Linearity Assumption and the

Relevant Range
Economist’s AA straight
s a gh line
ne
closely
c ose y
Curvilinear Cost approximates
app ox ma es aa
Function curvilinear
cu vi nea
variable
va ab ecostcos
Relevant line
ne within
w h n the
he
relevant
e evan range.
ange
Total Cost

Range
Accountant’s Strai
Straight-Line
Approximation (constant
unit variable cost)
(co unit
variable
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

90
Rent Cost in Thousands

The
The relevant
e evan rangeange
ofoactivity
act vfory aofixed
Relevant costt is the range of
a
60
of Dollars

xed cos s he
Range activity
ange overviwhich
o act y ove
thechgraph
wh he g of theo
aph
cost heis flat.
30 cos s a

0
0 1,000 2,000 3,000
Rented Area (Square Feet)
 2-27

Cost Classifications for Predicting Cost

Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit
Variable Total variable cost Variable cost per
Increase unit
and decrease in proportion remains constant.
to changes in the activity
Fixed Total fixed cost is not
level. Fixed cost per unit decreases as
affected the activity level rises and
by changes in the activity increases as the activity level
level within the relevant falls.
range.
 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 mixed cost contains both variable and fixed
A m xed cos contains both var able and xed
elements. Consider the example of utility
elements. Consider he example of ut y cos cost.
Y
Total Utility Cost

t
cos
i xed
l m
ot a
T
Variable
Cost per
KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 2-31

Mixed Costs

Y
Total Utility Cost

o st
e dc
m ix
t a l
T o
Variable
Cost per
KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 2-32

Mixed Costs – An Example

If your fixed
yyour our mont
xxededthlymutility
moonncharge
hlhlyy utisut$40,
yy your
var
ccriablle cost
harhar ggeet isss$0. .03$40,
$40, perykilowatt
yourour va hour, and
va ab abyour
ee r
monthly
coscos activity
ss $0$0level
0303ispp2,000
erer kikikiilowatt
owowathours,
at what
hourhour andand yyoouuis
mmontonthlthe hlyy amount
aactct vvofyyour
y evelutility bill?
evel s s 2,2,000000 kk
oowwatat hourhours,s, wwhathat ss hehe
amamountount ofof yyourour utut yy
bibi ??
 2-33

Analysis of Mixed Costs

AAcccount
Account count AAand
Analysis nalnal
theyyEngineering
sisiss andandApproach
hehe
EEnginginneeee
ngng AApppp oach oach analysis, each account is
In account
classified as either varriiable or fixed
based
on the analyst’s knowledge of how
the account behavess..

The engineering approach

classifies
ccoosts based upon an industrial
engineer’s evaluation of production
methods, and material, labor, and
overhead rreequirements.
 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
Plo the
he data
da a points
po n s on
on aa graph
g aph (Total
(To a Cost
Cost YY “dependent
dependen
variable”
variab e vs.
vs.Activity
Act v yXX“independent
“independentvariable”).
variable”
Y
Total Maintenance Cost

Hours of Maintenance
 2-37

The High-Low Method – An Example

The variable
TThehe cost
vaper
varrhour
iiababof
llee
maintenance
coscostt perper is
equal to hour
hour the change
ofof
minmai
cost
aintdivided
ntenance byen
the
ancechange in hours.
ss equal equal
oo hhee
cchangehange nn
$2,400
ccost=ost$6.00/hour
didivv
400
dedded byby
hehe cchangehange
 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
 2-42

Quick Check 
Sales
Sa es salaries
salar es and
and commissions
comm ss onsare are$10,000
$10,000
when
when 80,000
80,000 units
uni s are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
uni s are
are sold.
sold. Using
Using the
he high-low
high-
method,
ow method,whatwhat
is the fixedxed
s he portion
po of
onsales
o
salaries andes
sales salar commissions?
and comm ss ons?
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
Sa es salaries
salar es and
and commissions
comm ss onsare are$10,000
$10,000
when
when 80,000
80,000 units
uni s are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
uni s are
are sold.
sold. Using
Using the
he high-low
high-
method,
ow method,whatwhat
is the fixedxed
s he portion
po of
onsales
o
salaries andes
sales salar commissions?
and comm ss ons?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.
c. $10,000
$10,000
d.
d. $12,000
$12,000
 2-44

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
TThimethod
hiss mmuses
etethod allhodof
the data
uses points
uses alalll to estimate
ofof hehe
the
datfixed
dataaand variable
poipoi ntntss cost
oo
estcomponents
est mmatateeofheahe
xxedmixed
ed andcost.
and varvar Th
The
The ee ggof
Thgoal oothis
alal method
ofof hihisiss
ablablee mtomfitetaetstraight
hodhod s s ooto the
line aa
ccostost stst athat
data a ghtminimizes
ght nene o o
the
ccomomponentsum p heof datsquared
hethe dataa haterrors.
hat
 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
Least regression
squares egression alsoalso prrovides
p ovides a s ata s c,
sttatisttic,
cal ed he R which s a measu e of he goodness
2

called the R2, which is a measurre of the

of of he egression ne o he data points.
goodness
 2-46

Comparing Results From

the Two Methods
The two
TThe hemethods
wwoo mm just
etetdiscussed
hodshods provide
ustust
diifferent estimat
didiscus tes
scus ofsed
sed theprfixed and
proviovidevariable
de
dd erercost
eentcomponents
nt eestst mmaaofes
f aesmixed
ofof hecost.
he xxeded
This is toand
beand vvarar ablablee ccostost
expected because each method
ccomomponentponentss oo aa mm xxeded
uses differing amounts of the data points to
ccooss
provide estimates.
LeastThi
t
Thiss ssregression
-squares o o bbee eeprovides
x xppeecc the
ed edmost
becaus ee eacheach mmetethodhod
accuratebecaus
estimate because it uses all the
usesuses didi erer ngng amamountountss ofof
data points.
hehe datdataa poipointntss oo prproviovidede
estest mmatates.es.
 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
Comparison of the Contribution Income
Statement
with the Traditional Income Statement
Traditional Format Contribution Format

Sales $ 100,000 Sales $ 100,000

Cost of goods sold 70,000 Variable expenses 60,000
Gross margin $ 30,000 Contribution $ 40,000
Selling & admin. expense 20,000 margin 30,000
Net operating income $ 10,000 Fixed expenses $ 10,000
Net operating income

Used primarily for

external reporting.
 2-49

Uses of the Contribution Format

The
The contribution
contr but on income
ncome statement
statement format
ormat iss used
used
as an internal
nternal planning and decis
decision-making
on-making tool.
ool
We
We will
w use this
his approach for:
or
1. Cost-volume-prof
1 .Cost-vo lume-profitanalys
analysis (Chapter 5)
s (Chapter 5).
2. Budgettng
2 .Budge ing(Chapter
(Chapter8)
8).
3. Segmented repor
3 .Segmented reporting of prof
ng of profit data
data (Chapter
(Chapter 6)
6).
4. Special
4 .Spec decisions
al decis such as
ons such as pr
pricing
cing and
and make-
make-
or-
or- buy
buy analysis
analys s (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:
Example You You have
have a
a job
job paying
paying $1,500
$1,500 per
per month
mon h in
in
your
your hometown.
home own You You have
have a
a job
job offer
o er in
in a
a neighboring
neighboring
city
city that
ha pays
pays $2,000
$2 000 per
per month.
mon h The
The commuting
commu ing cost
cos
to
o the
he city
city is
is $300
$300 per
per month.
mon h

Differential revenue is: Differential cost is:

$2,000 – $1,500 = $500 $300
 2-53

Opportunity Cost
The potential benefit that is
given up when one
alternative
is selected over another.
These costs are not
These cos s are not usua
usually enttered into the
y en ered nto he
accounting
account ng records
records of
of an
an
organi zation, but must
organ iza on ,bu mus be
be
expl c y cons dered n a
explicitly
dec s onsconsidered in all
decisions.
Wha are he opportun
What
y cos are the
s you ncur o a end
opportuniity costs you
h s c ass?
incur to attend thiis
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 don’t 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 don’t 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 don’t 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 don’t 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