2-1

Chapter 2

Managerial Accounting and Cost

Concepts
 2-2

Cost Classifications for Assigning

Costs to Cost object

• Direct Cost • Indirect Cost

An indirect cost is a cost
A direct cost is a cost that that cannot be easily and
can be easily and conveniently traced to a
conveniently traced to specified cost object.
specified cost object.
Example:
Example:
Indirect material, Indirect
Direct material, Direct labor. labor.
 2-3

Cost Classification for Manufacturing

Companies
Classifications of Manufacturing Costs

Direct
Direct Direct Manufacturing
Manufacturing
Direct
Materials
Materials Labor Overhead
Overhead
Labor

The Product
 2-4

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
 2-5

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
 2-6

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
 2-7

Nonmanufacturing Costs

Administrative
Costs

All executive,
organizational, and
clerical costs.
 2-8

Cost Classification for Preparing

Financial Statements

Product costs include direct Period costs include all

materials, direct labor, and selling costs and
manufacturing overhead. administrative costs.
Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 2-9

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.
 2-10

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.
 2-11

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

Prime Conversion
Cost Cost
 2-12

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.
 2-13

Variable Cost
Your total texting bill is based on how many texts you send.
Total Texting Bill

Number of Texts Sent

 2-14

Variable Cost Per Unit

The cost per text sent is constant at

5 cents per text message.

Cost Per Text Sent

Number of Texts Sent

 2-15

The Activity Base (Cost Driver)

Units Machine
produced hours

A measure of what
causes the
incurrence of a
variable cost

Miles Labor
driven hours
 2-16

Fixed Cost

Your monthly contract fee for your cell phone is fixed for the number of
monthly minutes in your contract. The monthly contract fee does not change
based on the number of calls you make.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

Within Monthly Plan
 2-17

Within the monthly contract allotment, the average fixed cost per cell phone call
made decreases as more calls are made.

Fixed Cost Per Unit

Monthly Cell Phone

Contract Fee

Number of Minutes Used

Within Monthly Plan
 2-18

Types of Fixed Costs

Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced in short-term by current
the short term. managerial decisions

Examples Examples
Depreciation on Buildings Advertising and
and Equipment and Real Research and
Estate Taxes Development
 2-19

Fixed Costs and the Relevant

Range
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.
 2-20

Cost Classifications for Predicting

Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit

Variable Total variable cost Increase Variable cost per unit

and decrease in proportion remains constant.
to changes in the activity level.
Fixed Total fixed cost is not affected Fixed cost per unit decreases
by changes in the activity as the activity level rises and
level within the relevant range. increases as the activity level falls.
 2-21

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.
 2-22

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.
 2-23

Mixed Costs
(also called semivariable 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.
Y
Total Utility Cost

o st
d c
xe
al mi
t
To Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 2-24

Mixed Costs

Y
Total Utility Cost

ost
d c
ixe
al m
t
To Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 2-25

Mixed Costs – An Example

IfIf your
your fixed
fixed monthly
monthly utility
utility charge
charge is is $40,
$40, your
your
variable
variable cost
cost is
is $0.03
$0.03 per
per kilowatt
kilowatt hour,
hour, and
and your
your
monthly
monthly activity
activity level
level is
is 2,000
2,000 kilowatt
kilowatt hours,
hours, what
what is
is
the
the amount
amount of of your
your utility
utility bill?
bill?
 2-26

Scattergraph Plots – An Example

Assume the following hours of maintenance work and the total maintenance costs for six months.
 2-27

The Scattergraph Method

Plot
Plot the
the data
data points
points on
on aa graph
graph
(Total
(Total Cost
Cost YY vs.
vs. Activity
Activity X).
X).
Y
Total Maintenance Cost

Hours of Maintenance
 2-28

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
 2-29

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
 2-30

The High-Low Method – An

Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
 2-31

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

 2-32

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
 2-33

Quick Check 
Sales
Sales salaries
salaries and
and commissions
commissions areare $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
 2-34

Quick Check 
Sales
Sales salaries
salaries and
and commissions
commissions areare $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
 2-35

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.
 2-36

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.
 2-37

Learning Objective 5

Prepare income statements

for a merchandising
company using the
traditional and
contribution formats.
 2-38

The Traditional and Contribution

Formats

Used primarily for

external reporting.
 2-39

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 andand 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-or-
make-or-
buy
buy analysis
analysis (Chapter
(Chapter 12).
12).
 2-40

Assigning Costs to Cost Objects

Direct costs Indirect costs
• Costs that can be • Costs that cannot
easily and be easily and
conveniently traced to conveniently traced
a unit of product or to a unit of product
other cost object. or other cost object.
• Examples: direct • Example:
material and direct manufacturing
labor overhead
 2-41

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.
 2-42

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: Differential cost is:

$2,000 – $1,500 = $500 $300
 2-43

Opportunity Cost
The potential benefit that is given up
when one alternative is selected over
another.
Example: If you were
not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for
one year is $15,000.
 2-44

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

$400 an ounce, but now it is selling for $250 an
ounce. Should you wait for the gold to reach $400 an
ounce before selling it? You may say, “Yes” even
though the $400 purchase is a sunk costs.
 2-45

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.
 2-46

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.
 2-47

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.
 2-48

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.
 2-49

Summary of the Types of Cost

Classifications
Financial Predicting Cost
Reporting Behavior

Assigning Costs Making Business

to Cost Objects Decisions