1. An Introduction to Managerial Accounting and Cost Concepts
Chapter 1
An Introduction to Managerial Accounting and Cost Concepts
Chapter 1: An Introduction to Managerial Accounting and Cost Concepts.
This chapter serves three main purposes. First, it describes the work of management and the need for managerial accounting information. Second, it compares financial accounting and managerial accounting. Third, it discusses the four main uses of cost information―to prepare external financial reports, to predict cost behavior, to assign costs to cost objects, and to make business decisions.

2. Directing and Motivating
Work of Management
Planning
Directing and Motivating
Controlling
Managers carry out three major activities – planning, directing and motivating, and controlling.

3. Planning Identify alternatives.
Select alternative that does the best job of furthering organization’s objectives.
Develop budgets to guide progress toward the selected alternative.
Planning involves selecting a course of action and specifying how the action will be implemented. An important part of planning is to identify alternatives and then to select from among the alternatives the one that does the best job of furthering the organization’s objectives. Once alternatives have been identified, the plans of management are often expressed formally in budgets. Budgets are usually prepared under the direction of the controller, who is the manager in charge of the accounting department. Typically, budgets are prepared annually.

4. Directing and Motivating
Directing and motivating involves managing day-to-day activities to keep the organization running smoothly.
Employee work assignments.
Routine problem solving.
Conflict resolution.
Effective communications.
In addition to planning for the future, managers must oversee day-to-day activities to keep the organization running smoothly. Managerial accounting data, such as daily sales reports, are often used in this type of day-to-day decision making.

5. The control function ensures that plans are being followed.
Controlling
The control function ensures that plans are being followed.
Feedback in the form of performance reports that compare actual results with the budget are an essential part of the control function.
In carrying out the control function, managers seek to ensure that the plan is being followed. Feedback, which signals whether operations are on target, is the key to effective control. One type of feedback that is very helpful to mangers is called a performance report. A performance report compares budgeted to actual results. It suggests where operations are not proceeding as planned and where some parts of the organization may require additional attention.

6. Planning and Control Cycle
Formulating long-and short-term plans (Planning)
Begin
Comparing actual to planned performance (Controlling)
Implementing plans (Directing and Motivating)
Decision Making
The work of management, which is known as the planning and control cycle, is summarized on your screen. The process is a continuous loop in many organizations. Once plans are made, they are implemented. The controlling process starts with measuring actual performance, and then comparing those results with planned performance. Corrective action may be necessary if actual results differ significantly from the plan. In some cases, new information may result in altering the plan before the cycle is repeated. Note that decision making is involved in all management activities.
Measuring performance (Controlling)

7. Comparison of Financial and Managerial Accounting
There are seven key differences between managerial accounting and financial accounting:
Financial accounting reports are prepared for external parties, whereas, managerial accounting reports are prepared for internal users.
Financial accounting summarizes past transactions. Managerial accounting has a future orientation.
Financial accounting data are expected to be objective and verifiable. Managerial accountants focus on providing relevant data even if it is not completely objective or verifiable.
Financial accounting focuses on precision when reporting to external parties. Managerial accounting aids decision makers by providing good estimates as soon as possible rather than waiting for precise data later.
Financial accounting is concerned with reporting for the company as a whole. Managerial accounting focuses more on the segments of the company. Examples of segments include: Product lines, sales territories, divisions, departments, etc.
Financial accounting conforms to GAAP. Managerial accounting is not bound by GAAP.
Financial accounting is mandatory because various outside parties require periodic financial statements. Managerial accounting is not mandatory.

8. Learning Objective 1
Identify and give examples of each of the three basic manufacturing cost categories.
Learning objective number 1 is to identify and give examples of each of the three basic manufacturing cost categories.

9. Manufacturing Overhead
Manufacturing Costs
Direct Materials
Direct Labor
Manufacturing Overhead
Manufacturing costs are usually grouped into three main categories: direct materials, direct labor, and manufacturing overhead. These costs are incurred to make a product.
The Product

10. Example: A radio installed in an automobile
Direct Materials
Raw materials that become an integral part of the product and that can be conveniently traced directly to it.
Direct materials are raw materials that become an integral part of the finished product and that can be physically and conveniently traced to it.
Examples include the aircraft engines on a Boeing 777, the Intel processing chip in a personal computer, the blank video cassette in a pre-recorded video, and a radio in an automobile.
Example: A radio installed in an automobile

11. Example: Wages paid to automobile assembly workers
Direct Labor
Those labor costs that can be easily traced to individual units of product.
Direct labor consists of that portion of labor cost that can be easily traced to a product. Direct labor is sometimes referred to as “touch labor” since it consists of the costs of workers who “touch” the product as it is being made.
Example: Wages paid to automobile assembly workers

12. Manufacturing Overhead
Manufacturing costs cannot be traced directly to specific units produced.
Examples: Indirect materials and indirect 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.
Manufacturing overhead includes all manufacturing costs except direct materials and direct labor. These costs cannot be easily traced to specific units produced (also called indirect manufacturing cost, factory overhead, and factory burden). Manufacturing overhead includes indirect materials that are part of the finished product, but that cannot be easily traced to it and indirect labor costs that cannot be physically or conveniently traced to the creation of products. Other examples of manufacturing overhead include: maintenance and repairs on production equipment, heat and light, property taxes, depreciation and insurance on manufacturing facilities, and salaries for supervisors, janitors, and security guards.

13. Classifications of Nonmanufacturing Costs
Selling Costs
Costs necessary to get the order and deliver the product.
Administrative Costs
All executive, organizational, and clerical costs.
A manufacturing company incurs many other costs in addition to manufacturing costs. For financial reporting purposes, most of these other costs are typically classified as selling costs and administrative costs. These costs are also called selling, general and administrative costs, or SG&A. Selling and administrative costs are incurred in both manufacturing and merchandising firms.
Selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customer. These costs are also referred to as order-getting and order-filling costs.
Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization that are not classified as production or marketing costs.

14. Learning Objective 2
Distinguish between product costs and period costs and give examples of each.
Learning objective number 2 is to distinguish between product costs and period costs and give examples of each.

15. Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing overhead.
Period costs are not included in product costs. They are expensed on the income statement.
Inventory
Cost of Goods Sold
Balance Sheet
Income Statement
Sale
Expense
Income Statement
Costs can also be classified as product or period costs.
Product costs include all the costs that are involved in acquiring or making a product. In the case of manufactured goods, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle, product costs are recognized as expenses when the products are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and when it appears as an expense on the income statement. Product costs are also known as inventoriable costs. The discussion in the chapter follows the usual interpretation of GAAP, whereby all manufacturing costs are treated as product costs.
Period costs include all selling and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are “incurred” when they are earned by the employees and not necessarily when they are paid to employees.

16. 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.
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.

17. 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.
Property taxes on corporate headquarters and sales commissions are period costs. All of the other costs listed are product costs.

18. Prime Cost and Conversion Cost
Manufacturing costs are often classified as follows:
Direct Material
Direct Labor
Manufacturing Overhead
Prime Cost
Conversion Cost
Prime cost consists of direct materials plus direct labor. Conversion cost consists of direct labor plus manufacturing overhead.

19. Comparing Merchandising and Manufacturing Activities
Merchandisers . . .
Buy finished goods.
Sell finished goods.
Manufacturers . . .
Buy raw materials.
Produce and sell finished goods.
MegaLoMart
Merchandising companies purchase finished goods from suppliers for resale to customers. Manufacturing companies purchase raw materials from suppliers and produce and sell finished goods to customers.

20. Balance Sheet Merchandiser Manufacturer Current Assets Current Assets
Cash
Receivables
Prepaid Expenses
Merchandise Inventory
Manufacturer
Current Assets
Cash
Receivables
Prepaid Expenses
Inventories:
Raw Materials
Work in Process
Finished Goods
Now, let’s consider the similarities and differences on the balance sheet for merchandising and manufacturing companies. Both merchandising and manufacturing companies will likely have Cash, Receivables and Prepaid Expenses. However, merchandising companies do not have to distinguish between raw materials, work in process, and finished goods. They report one inventory number on their balance sheet labeled merchandise inventory. Manufacturing companies report three types of inventory on their balance sheets: raw materials, work in process and finished goods.

21. Materials waiting to be processed. Completed products awaiting sale.
Balance Sheet
Merchandiser
Current Assets
Cash
Receivables
Prepaid Expenses
Merchandise Inventory
Manufacturer
Current Assets
Cash
Receivables
Prepaid Expenses
Inventories:
Raw Materials
Work in Process
Finished Goods
Materials waiting to be processed.
Partially complete products – some material, labor, or overhead has been added.
Part I
Raw materials are the materials used to make the product.
Part II
Work in process consists of units of product that are partially complete, but will require further work to be saleable to customers.
Part III
Finished goods consists of units of product that have been completed, but not yet sold to customers.
Completed products awaiting sale.

22. Learning Objective 3
Prepare an income statement including calculation of the cost of goods sold.
Learning objective number 3 is to prepare an income statement including calculation of the cost of goods sold.

23. The Income Statement
Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.
Merchandising companies calculate cost of goods sold as Beginning Merchandise Inventory plus Purchases minus Ending Merchandise Inventory.
For manufacturing companies, the cost of goods sold for a period is not simply the manufacturing costs incurred during the period. They calculate cost of goods sold as Beginning Finished Goods Inventory plus Cost of Goods Manufactured minus Ending Finished Goods Inventory. For a manufacturing company, some of the cost of goods sold may be for units completed in a previous period. And some of the units completed in the current period may not have been sold and will still be on the balance sheet as an asset. The cost of goods sold is computed with the aid of a schedule of costs of goods manufactured, which takes into account changes in inventories. The schedule of cost of goods manufactured is not ordinarily included in external financial reports, but must be compiled by accountants within the company in order to arrive at the cost of goods sold. We will learn more about a schedule of costs of goods manufactured later in this chapter.

24. Additions to inventory
Inventory Flows
Beginning
balance
Additions to inventory + =
Ending
Withdrawals from
inventory
The computation of Cost of Goods Sold relies on this basic equation for inventory accounts: beginning inventory balance plus additions to inventory equals ending inventory balance plus withdrawals from inventory. The logic underlying this equation applies to any inventory account. Any units that are in inventory at the beginning of the period appear as the beginning balance. During the period, additions are made to the inventory through purchases or other means. At the end of the period, everything that was in the beginning inventory or that was added must be in the ending inventory account or have been transferred out to another inventory account or to cost of goods sold.

25. Quick Check 
If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month?
A. $1,000.
B. $
C. $1,200.
D. $
If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month?

26. Quick Check 
If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month?
A. $1,000.
B. $
C. $1,200.
D. $
$1,000 + $100 = $1,100
$1,100 - $300 = $800
Right. $800. This is calculated as beginning inventory of $1,000 plus purchases of $100 minus ending inventory of $300.

27. Prepare a schedule of cost of goods manufactured.
Learning Objective 4
Prepare a schedule of cost of goods manufactured.
Learning objective number 4 is to prepare a schedule of cost of goods manufactured.

28. Schedule of Cost of Goods Manufactured
Calculates the cost of raw material, direct labor and manufacturing overhead used in production.
Calculates the manufacturing costs associated with goods that were finished during the period.
The schedule of cost of goods manufactured contains the three elements of costs mentioned previously, namely, direct materials, direct labor, and manufacturing overhead. The purpose of the schedule is to calculate the cost of raw materials, direct labor, and manufacturing overhead used in production. In addition, it is used to calculate the manufacturing costs associated with goods that were finished during the period.

29. Schedule of Cost of Goods Manufactured
As items are removed from raw materials inventory and placed into the production process, they are called direct materials.
At first glance, the schedule of cost of goods manufactured appears complex. However, it is all quite logical. The schedule of cost of goods manufactured contains the three types of product costs that we discussed earlier—direct materials, direct labor, and manufacturing overhead.
The raw materials cost is not simply the cost of raw materials purchased during the period—rather it is the cost of materials used during the period. Raw material purchases made during the period are added to the beginning raw materials inventory balance to determine the cost of materials available for use during the period. The ending materials inventory is deducted from this amount to arrive at the cost of raw materials used in production. As items are removed from raw materials inventory and placed into the production process, they are called direct materials.

30. Schedule of Cost of Goods Manufactured
Conversion costs are costs incurred to convert the direct material into a finished product.
After we calculated the raw materials used in production, we take that amount and add the conversion costs (direct labor and manufacturing overhead) to get total manufacturing costs for the period.
As items are removed from raw materials inventory and placed into the production process, they are called direct materials.

31. Schedule of Cost of Goods Manufactured
After we calculate our total manufacturing costs, we take beginning work in process inventory, add to that, total manufacturing costs, and we get the total work in process for the period.
All manufacturing costs incurred during the period are added to the beginning balance of work in process.

32. Schedule of Cost of Goods Manufactured
Finally, we subtract ending work-in-process inventory from work in process for the period to get cost of goods manufactured. Completed goods are transferred to finished goods inventory.
Costs associated with the goods that are completed during the period are transferred to finished goods inventory.

33. Cost of Goods Sold
You can see that the cost of goods manufactured is added to the beginning finished goods inventory to get the cost of goods available for sale. The ending finished goods inventory is subtracted to arrive at the cost of goods sold.

34. Manufacturing Cost Flows
Balance Sheet Costs Inventories
Income Statement Expenses
Material Purchases
Raw Materials
Manufacturing Overhead
Work in Process
Direct Labor
Finished Goods
Cost of Goods Sold
Part I
Let’s briefly look at the flow of costs in a manufacturing company. This will help us understand how product costs move through the various accounts and how they affect the balance sheet and the income statement.
Raw materials are purchased and placed into raw materials inventory.
Part II
Raw materials are requisitioned out of raw materials inventory into work in process. Direct labor and manufacturing overhead are charged directly to work in process inventory.
Part III
When we complete the product, the product and its costs are transferred out of work in process inventory into finished goods. All raw materials, work in process and unsold finished goods at the end of the period are shown as inventoriable costs in the asset section of the balance sheet.
Part IV
As finished goods are sold, their costs are transferred to cost of goods sold on the income statement.
Part V
Selling and administrative expenses are not involved in making the product; therefore, they are treated as period costs and reported in the income statement for the period the cost is incurred.
Selling and Administrative
Selling and Administrative
Period Costs

35. Quick Check 
Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000
Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used?

36. Quick Check 
Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000
Right. $280,000. Take a minute and review the solution before proceeding.

37. Quick Check 
Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.
Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month?

38. Quick Check 
Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.
Right. $835,000. Take a minute and review the solution before proceeding.

39. Quick Check 
Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month?

40. Quick Check 
Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
Right. $760,000. Take a minute and review the solution before proceeding.

41. Quick Check 
Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. The ending finished goods inventory was $150,000. What was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. The ending finished goods inventory was $150,000. What was the cost of goods sold for the month?

42. Quick Check 
Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. The ending finished goods inventory was $150,000. What was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
$130,000 + $760,000 = $890,000
$890,000 - $150,000 = $740,000
Right. $740,000. Take a minute and review the solution before proceeding.

43. Define and give examples of variable costs and fixed costs.
Learning Objective 5
Define and give examples of variable costs and fixed costs.
Learning objective number 5 is to define and give examples of variable costs and fixed costs.

44. Cost Classifications for Predicting Cost Behavior
How a cost will react to changes in the level of business activity.
Total variable costs change when activity changes.
Total fixed costs remain unchanged when activity changes.
Managers often need to be able to predict how costs will change in response to changes in activity. The activity might be the output of goods or services or it might be some measure of activity, internal to the company, such as the number of purchase orders processed during a period. In this chapter, nearly all of the illustrations assume that the activity is the output of goods or services. In later chapters, other measures of activity will be introduced.
Cost behavior refers to how a cost will react to changes in the level of activity within the relevant range. The most commonly used classifications of cost behavior are variable and fixed costs, which we will discuss in this chapter. The total of just about any cost will change if there is a big enough change in activity. There is some controversy concerning the proper definition of the “relevant range.” Some refer to the relevant range as the range of activity within which the company usually operates. We refer to the relevant range as the range of activity within which the assumptions about variable and fixed costs are valid. Either definition could be used—our choice was dictated by our desire to highlight the notion that fixed costs can change if the level of activity changes enough.

45. Total Long Distance Telephone Bill
Total Variable Cost
Your total long distance telephone bill is based on how many minutes you talk.
Minutes Talked
Total Long Distance Telephone Bill
A variable costs varies, in total, in direct proportion to changes in the level of activity. For example, your long distance telephone bill may be based on how many minutes you talk—the total bill varies with the number of minutes used.

46. Per Minute Telephone Charge
Variable Cost Per Unit
The cost per long distance minute talked is constant. For example, 10 cents per minute.
Minutes Talked
Per Minute Telephone Charge
Although variable costs change in total as the activity level rises and falls, variable cost per unit is constant. For example, the cost per long distance minute may be ten cents a minute.

47. Monthly Basic Telephone Bill
Total Fixed Cost
Your monthly basic telephone bill probably does not change when you make more local calls.
Number of Local Calls
Monthly Basic Telephone Bill
A fixed cost remains constant, in total, within the relevant range, regardless of changes in the level of the activity. In other words, fixed costs do not change as long as the activity level falls within the “relevant range.” For example, your monthly basic telephone bill probably is a set amount and does not change based on the number of local calls you make.

48. Monthly Basic Telephone Bill per Local Call
Fixed Cost Per Unit
The average fixed cost per local call decreases as more local calls are made.
Number of Local Calls
Monthly Basic Telephone Bill per Local Call
When expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity. In other words, for a fixed cost, the per unit cost decreases when activity rises and increases when activity falls. For example, the average fixed cost per local call decreases as more local calls are made.

49. Cost Classifications for Predicting Cost Behavior
It is helpful to think about variable and fixed cost behavior in a two by two matrix, as illustrated here. Take a few minutes and review this summary of cost behavior for variable and fixed costs.

50. 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.
Which of the following costs would be variable with respect to the number of cones sold at a Baskins and 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.

51. 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.
Right. The cost of ice cream and the cost of napkins for customers would be variable costs. As Baskins and Robbins sells more ice cream cones, we would expect the total cost of ice cream and napkins to increase.

52. Define and give examples of direct and indirect costs.
Learning Objective 6
Define and give examples of direct and indirect costs.
Learning objective number 6 is to define and give examples of direct and indirect costs.

53. Assigning Costs to Cost Objects
Direct costs
Costs that can be easily and conveniently traced to a unit of product or other cost object.
Examples: Direct material and direct labor
Indirect costs
Costs that cannot be easily and conveniently traced to a unit of product or other cost object.
Example: Manufacturing overhead
A cost object is anything for which cost data are desired including products, customers, jobs, organizational subunits, etc. For purposes of assigning costs to cost objects, costs are classified two ways:
Direct costs are costs that can be easily and conveniently traced to a unit of product or other cost object. Examples of direct costs are direct material and direct labor.
Indirect costs are costs that cannot be easily and conveniently traced to a unit of product or other cost object. An example of an indirect cost is manufacturing overhead. Common costs are indirect costs incurred to support a number of cost objects. These costs cannot be traced to any individual cost object.

54. Learning Objective 7
Define and give examples of cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.
Learning objective number 7 is to define and give examples of cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.

55. 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 to the decision. All other costs and benefits can and should be ignored.
It is important to realize that every decision involves a choice between at least two alternatives. The goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision. Costs and benefits that differ between alternatives are relevant to the decision. All other costs and benefits are irrelevant and can and should be ignored. To make decisions, it is essential to have a grasp on three concepts: Differential costs, opportunity cost, and sunk cost. Let’s take a look at each of these on the next few slides.

56. Differential Costs and Revenues
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 costs (or incremental costs) is a difference in cost between any two alternatives. A difference in revenue between two alternatives is called differential revenue. Differential costs can be either fixed or variable.
For example, assume 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. In this example, the differential revenue is $500 and the differential cost is $300. The net differential benefit associated with accepting the new job is $200.
Differential revenue is:
$2,000 – $1,500 = $500
Differential cost is:
$300
Net Differential Benefit is:
$200

57. Opportunity Costs
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.
An opportunity cost is the potential benefit that is given up when one alternative is selected over another. These costs are not usually entered into the accounting records of an organization, but must be explicitly considered in all decisions.

58. Sunk Costs
Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions.
Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.
A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Since sunk costs cannot be changed, they cannot be differential costs; therefore, sunk costs should be ignored in decision making. While students usually accept the idea that sunk costs should be ignored on an abstract level, like most people, they often have difficulty putting this idea into practice.

59. 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.
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?

60. 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.
Yes, it should be considered because the cost of the train ticket is relevant.

61. 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.
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?

62. 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.
No, the licensing cost is not relevant.

63. 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.
Suppose that your car could be sold now for $5,000. Is this a sunk cost?

64. 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.
No, it is not a sunk cost.

65. Summary of the Types of Cost Classifications
Financial Reporting
Predicting Cost Behavior
We have looked at the cost classifications used for financial reporting, predicting cost behavior, assigning costs to cost objects, and making business decisions.
Assigning Costs to Cost Objects
Decision Making

66. End of Chapter 1
End of chapter 1.