1. Managerial Accounting and Cost Cocepts

2. Learning Objectives
Explain cost terms and classifications for financial reporting: period vs. product cost
Describe the components of product cost
Calculate ‘cost of goods manufactured’ and ‘cost of goods sold’ for a manufacturing entity
Explain cost terms and classifications for decision making: direct/indirect; variable/fixed; controllable/non-controllable; opportunity, differential, sunk, and quality
Understand quality costs

3. Cost Classifications
Cost classifications that are used depend on the reason for cost data accumulation.
There are two main reasons for cost accumulation:
financial reporting (asset and income measurements, i.e., cost accounting)
decision making (e.g., resource allocation, motivation, pricing)

4. Cost Classification for Financial Reporting
For financial reporting, costs are classified into:
Period costs
Product costs
This classification simply refers to whether a cost (an expenditure) is related to a period or a product, and thus the time in which the expenditure is recognized as expense.

5. Period Costs
Also known as selling, general and administrative expenses, period costs are related to time periods, i.e., they are incurred every period.
Examples are salaries of sales and administrative personnel.
Period costs are therefore expensed in the period incurred (not paid).

6. Product Costs
Also known as inventoriable, factory or manufacturing costs, product costs are related to products (or production activities).
Examples are salaries of factory personnel and factory utility costs.
Product costs are therefore treated as assets (inventories) until the products are sold at which time they are expensed as cost of goods sold.

7. Classification of Product Costs
Prime
Conversion
Direct Materials
Direct Labor
(Manufacturing) Overhead
The Product

8. Direct Materials
Materials that can be easily and physically identified as part of the product
e.g., chips in a computer
Small items such as glue and screws, and items that do not become part of the product, are considered indirect materials and their cost is part of overhead cost.

9. Direct Labor
Salaries/wages paid to employees who convert direct materials into finished products.
Direct labor costs can be easily and physically traced to specific units of products.
e.g., wages paid to computer assembly workers
The salaries/wages of other personnel in the factory (supervisors, janitors, custodians, security guards) are considered indirect labor cost and are part of overhead.

10. Overhead
All factory or manufacturing costs except direct materials and direct labor.
e.g., indirect materials, indirect labor, utilities, repair and maintenance, insurance, property taxes, rent, depreciation
Idle time and overtime premiums are part of overhead costs.
Fringe benefits is considered overhead in its entirety by some companies; others only consider fringe benefits for indirect labor as overhead and the rest as direct labor.

11. Other Cost Classifications
In process industries such as steel, chemical and paper, direct labor cost is not normally accumulated separately; direct labor and overhead are combined and called conversion or processing cost.
In today’s manufacturing environment, direct labor cost (<10% of total cost) is not normally separately accumulated; the machining cost (the rent or depreciation, utilities, maintenance, engineering, and other machine related costs) is.

12. Quick Test
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.

13. Quick Test
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.

14. Flow of Manufacturing Costs
Traditionally, costs follow the physical flow of goods, i.e., they move as goods move through the manufacturing process and sale.
e.g., cost of materials are transferred to work-in-process as materials are released to production floor.

15. Flow of Manufacturing Costs
Direct materials Work-in-process Finished goods
BI BI BI
Purchases DM used DM used COGM COGM COGS
EI DL EI
OH applied* EI
Cost of goods sold
COGS

16. Application of Overhead
OH is normally applied (allocated) on the basis of a plant-wide rate, departmental rates, or activity rates.
There is an overhead account that is debited for overhead cost incurred and credited for overhead applied.

17. Selling and Administrative Costs
Selling costs are costs necessary to secure the order and deliver the product.
Administrative costs are executive, organizational, and clerical costs.

18. Cost Classifications for Decision Making
For decision making, costs are classified in several ways:
Direct vs. Indirect
Variable vs. Fixed
Controllable vs. Non-controllable
Other

19. Direct Costs vs. Indirect Costs
This classification is mainly used in evaluating the performance of a segment
e.g., product, product line, department, division

20. Direct Costs vs. Indirect Costs
Direct costs of a segment (cost object) are costs incurred for the sole benefit of the segment.
e.g., salary of segment manager
They will be eliminated if the segment is eliminated.
Indirect costs are costs incurred for the common benefit of two or more segments.
e.g., salary of general manager
They will not be eliminated if one of the segments is eliminated.
The basic idea is that any segment of the company should at least cover its own direct costs.

21. Quick Test
Which of the following costs would be a direct cost of a unit of product?
A. A foreman’s salary.
B. Leather to make jackets.
C. Lubrication for machinery.
D. Wages of workers who make jackets.

22. Quick Test
Which of the following costs would be a direct cost of a unit of product?
A. A foreman’s salary.
B. Leather to make jackets.
C. Lubrication for machinery.
D. Wages of workers who make jackets.

23. Controllable vs. Non-controllable Costs
This classification is mainly used in evaluating a segment manager’s performance.

24. Controllable vs. Non-controllable Costs
Controllable costs to a particular manager are those that he/she can authorize, or significantly influence.
e.g., segment manager decides how much to spend on marketing
Non-controllable costs are those that an upper level manager can authorize.
e.g., CEO decides how much to spend on marketing
The basic idea is that responsibility should be commensurate with authority, i.e., a manager can not be held responsible for what he/she cannot control.

25. Quick Test
Which of the following costs would be controllable by a manager at a Baskins & Robbins shop?
A. The cost of lighting the store.
B. The wages of part-time servers (store managers hire servers).
C. The rent for the store (district managers select store locations and negotiate rental charges with property owners).

26. Quick Test
Which of the following costs would be controllable by a manager at a Baskins & Robbins shop?
A. The cost of lighting the store.
B. The wages of part-time servers (store managers hire servers).
C. The rent for the store (district managers select store locations and negotiate rental charges with property owners).

27. Variable Costs vs. Fixed Costs
This classification is widely used in managerial accounting, e.g., in CVP analysis, budgeting, standard costing, segment reporting, and special decisions.

28. Variable Costs vs. Fixed Costs
Variable costs vary in total in direct proportion to the level of activity.
They are fixed per unit of activity.
Fixed costs stay the same in total regardless of the level of activity.
They vary per unit of activity.
Units produced
DL cost
Total
Per unit
Units produced
Rent
Total
Per unit

29. What is an Activity? Cost Driver?
An activity is a transaction or event that involves cost.
e.g., production; purchase order; material handling and cutting
Every activity has one or more cost drivers.
e.g., number of units produced; number of orders processed; type of material, its weight, or volume.

30. Variable Costs vs. Fixed Costs
Both variable and fixed cost definitions are true within the relevant range (the range of normal activity) and within a time frame.
No cost is fixed over all activity levels or over a very long period of time.
Cost that vary in steps (such as supervisory salaries) are called step-variable or step-fixed costs.

31. Types of Variable Costs
Variable costs can be:
Engineered – causally related to level of activity
Discretionary – decided on by management as part of the budget

32. Types of Fixed Costs Fixed costs can be:
Committed – related to possession of plant and equipment and existence of the organization
Discretionary (or managed)– decided on by management as part of the budget

33. Mixed (Semi-Variable) Costs
Mixed costs are costs that contain both variable and fixed components, e.g., utilities.
Costs aggregated in various ways are also mixed, e.g., overhead or machining.
The fixed component represents the minimum cost of having a service available for use; the variable component represents the cost of actual consumption.
Graphically, a mixed cost is represented by a straight line that intersects the vertical (Y) axis.

34. Mixed (Semi-Variable) Costs
Variable Utility charge
Total mixed cost
Fixed Utility charge

35. Mixed (Semi-Variable) Costs
Variable Utility charge
Total mixed cost
Fixed Utility charge

36. Quick Test
Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop?
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.

37. Quick Test
Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop?
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.

38. Other Cost Terms
Opportunity cost is the potential benefit that is given up when one alternative is selected over another.
e.g., by deciding to make a component for a product, a company experiences an opportunity cost because it gives up the profit that would be realized by using the facilities to make another product.
This cost is not a cash outlay and is not recorded in the books, but is relevant in any managerial decision.

39. Other Cost Terms
Incremental (differential) cost is the change in cost as a result of taking a given course of action.
This concept is mainly used in making special decisions.
e.g., what would the increase in cost be as a result of accepting a special order.
Economists refer to incremental cost as increase in cost as a result of a “one” unit increase in activity.

40. Other Cost Terms
Sunk cost is cost incurred in the past that can not be recovered.
Past costs are always irrelevant and should be ignored in all managerial decisions. Decisions should be based on present and future cash flows.
For example, in deciding to replace an asset, we ignore its original cost (not the cash resale price of the asset or the tax loss shield).

41. Traditional and Contribution Formats
Used primarily for external reporting.
Used primarily by management.

42. Uses of the Contribution Format
The contribution income statement format is used as an internal planning and decision-making tool:
Cost-volume-profit analysis (Chapter 5).
Segmented reporting of profit data (Chapter 6).
Budgeting (Chapter 8).
Special decisions such as pricing and make-or-buy analysis (Chapter 12)

43. Costs of Quality Four Types of Quality Cost Prevention Costs
Appraisal Costs
Four Types of Quality Cost
Internal Failure Costs
External Failure Costs
ISO 9000 standards have become an international measure of quality.