Chapter 2: Managerial Accounting & Cost Concepts

Purpose of Cost classification

1. Assigning costs to cost objects 2. Accounting for costs in manufacturing companies 3. Preparing financial statements 4. Predicting cost behavior in response to changes in activity 5. Making decisions

Cost classifications

1. Direct cost (easily traced) 2. Indirect cost (can't be easily traced) 3. Manufacturing costs: direct materials, direct labor, manufacturing overhead 3. Nonfacturing costs: selling costs, administrative costs 4. Product costs (inventorial) 5. Period costs (expensed) 6. Variable cost( proportional to activity 7. Fixed cost (constant) 8. Mixed cost (variable & fixed elements) 9. Differential cost (differs b/w alternatives) 10. Sunk cost (should be ignored) 11. Opportunity cost (foregone benefit)

Nonmanfacturing costs

1. Selling costs: all costs that are incurred to secure customer orders & get the finished product to the customer= costs sometimes called order-getting/ order-filling costs Ex. advertising, shipping, sales travel, sales commissions, sales salaries, costs of finished goods warehouses Selling costs= indirect/ direct costs Ex. cost of an advertising campaign dedicated to 1 specific product= direct cost of that product Salary of a marketing manager who oversees numerous products= indirect cost w/ respect to individual products 2. Administrative costs: include all costs associated w/ general management of an organization rather than w/ manufacturing or selling. Ex. include executive compensation, general accounting, secretarial, public relations, & similar costs involved in overall, general administration of the organization as a whole. Can be either direct/ indirect costs Ex. salary of an accounting manager in charge of accounts receivable collections in the East region is a direct cost of that region, Salary of a chief financial officer who oversees all of a company's regions: indirect cost with respect to individual regions

Ex indirect cost

Campbell soup factory may produce dozens of varieties of canned soups. Factory manager's salary would be an indirect cost of a particular variety as chicken noodle soup

Direct labor

Consists of labor costs that can be easily & conveniently traced to individual units of product Direct labor= touch labor bc direct labor workers typically touch the product while its being made. ex. Assembly-line workers at Toyota, carpenters, electricians..

Product cost=

Direct materials + Direct labor + manufacturing overhead

Raw materials may include both direct & indirect materials

Direct materials: materials that become an integral part of the finished product & conveniently traced to the finished product Ex. Airbus purchases from subcontractors to install in its commercial aircraft electronic components that Apply uses in IPhone Indirect materials: solder & glue bc they are included as part in the manufacturing overhead

Ex. Direct cost

If Reebok assigned costs to regional & national sales offices then salary of the sales manager in Tokyo office= direct cost If printing company made 10,000 brochures for a specific customer, then cost of the paper used to make brochures= direct cost of customer

managers can use variety of methods to estimate fixed & variable components of a mixed costs

account analysis, engineering approach, high-low method, least-squares regression analysis

sunk cost

already been incurred and cannot be changed by any decision made now or in future

contribution margin

amount remaining from sales revenues after variable expenses have been deducted Amount contributes toward covering fixed expenses & then to profits for the period

Account analysis

an account is classified as either variable or fixed based on analyst's prior knowledge of how the cost in the account behaves

Cost object

anything for which cost data are desired- products, customers, jobs, & organizational subunits Costs are assigned to cost objects for: pricing, preparing profitability studies, & controlling spending

Costs are recognized

as expenses on income statement in period that benefits from the cost

Matching principle

based on accrual concept that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized If a cost is incurred to acquire/ make something that will eventually be sold, then cost should be recognized as an expense only when the sale takes place- when the benefit occurs= product costs

For planning purposes, fixed costs can be viewed as either

committed or discretionary

Factory's manager's salary is called..

common cost of producing the various products of the factory

Mixed cost

contains both variable & fixed cost elements Also known as semivariable costs

Direct cost

cost that can be easily & conveniently traced to a specific object

Indirect cost

cost that cannot be easily & conveniently traced to a specified cost object

Common cost: type of indirect cost

cost that is incurred to support a # of cost objects but cannot be traced to them individually.

Fixed cost

cost that remains constant, in total, regardless of changes in the level of activity. Ex. straight-line depreciation, insurance, property taxes, rent, supervisory salaries, administrative salaries, & advertising Not affected by changes in activity

Period costs

costs that are not product costs

differential cost

difference in costs b/w any 2 alternatives incremental cost: increase in cost from 1 alternative to another; decreases in cost should be referred to as decremental

differential revenue

difference in revenues (usually just sales) b/w any 2 alternatives

conversion cost

direct labor + manufacturing overhead

prime cost=

direct materials + direct labor

manufacturing costs divided into 3 categories:

direct materials, direct labor, & manufacturing overhead

Cost behavior

how a cost reacts to changes in the level of activity As level rises and falls, a particular cost may rise & fall as well or may remain constant

As general rule, we caution against expressing fixed costs on an average per unit basis

in internal reports bc it creates false impression that fixed costs are like variable costs & that total fixed costs actually change as level of activity changes

Engineering approach

to cost analysis involves a detailed analysis of what cost behavior should be, based on an industrial engineer's evaluation of the production methods to be used, the materials specifications, labor requirements, equipment usage, production efficiency, power consumption

Product costs

include all costs involved in acquiring or making a product In case of manufactured goods: costs consist of direct materials, direct labor, manufacturing overhead "attach" to units of product as the goods are purchased/ manufactured, remain attached as goods go into inventory for sale Initially assigned to an inventory account on balance sheet When goods are sold: costs are released from inventory as expenses (COGS) & matched against sales revenue on income statement Product costs are initially assigned to inventories, they known also as inventoriable costs

Activity base

is a measure of whatever causes the incurrence of a variable cost Referred to as cost driver Most common activity bases: direct labor-hours, machine-hours, units produced, units sold Cost driver ex: # of miles drives by salespersons, # of pounds of laundry cleaned by hotel, # driven of calls, # of beds in hospital

Indirect labor

labor costs that cannot be physically traced to particular products, or that can be traced only at great cost and inconvenience Treated as part of manufacturing overhead Labor costs of janitors, supervisors, material handlers, & night security guards

2 broad classifications of costs:

manufacturing and nonmanufacturing costs

indirect materials include:

nails, glue, and thread

All selling & administrative expenses are treated as

period costs Ex. sales commissions, advertising, executive salaries, public relations, rental costs of administrative offices Not included as part of the cost of either purchased/ manufactured goods; instead are expensed on income statement in period in which they are incurred using rules of accrual accounting Period in which a cost is incurred is not necessarily the period in which cash changes hands ex. Costs of liability insurance are spread across periods that benefit from the insurance- regardless of period in which insurance premium is paid

Opportunity cost

potential benefit that is given up when one alternative is selected over another

when preparing balance sheet/ income statement, companies need to classify their costs as

product costs/ period costs

contribution approach

provides managers w/ an income statement that clearly distinguishes b/w fixed & variable costs & therefore aids planning, controlling, & decision making

Relevant range

range of activity within which the assumption that cost behavior is strictly linear is reasonably valid

Cost structure

relative proportion of each type of cost in an organization

Committed fixed costs

represent organizational investments w/ multiyear planning horizon that can't be significantly reduced even for short periods of time w/o making fundamental changes Ex. investments in facilities & equipment

Period cost=

selling expenses + administrative expenses

Nonmanfacturing costs often called

selling, general, and administrative costs (SG&A) or just selling & administrative costs

Conversion cost

sum of direct labor cost & manufacturing overhead cost used to describe direct labor & manufacturing overhead bc these costs are incurred to convert materials into the finished product

Prime cost

sum of direct materials costs & direct labor cost

Traced as a cost object... such as a particular product

the cost must be caused by the cost object

Raw materials

the materials that go into the final product

Manufacturing overhead

the third manufacturing cost category, includes all manufacturing costs except direct materials & direct labor Includes indirect materials; indirect labor, maintenance & repairs on production equipment; heat & light, property taxes, depreciation, & insurance on manufacturing facilities Company also incurs costs for heat & light, property taxes, insurance, depreciation, associated w/ its selling & administrative functions, costs are included as part of manufacturing overhead Only those costs associated w/ operating the factory are included in manufacturing overhead Manufacturing overhead= indirect manufacturing cost, factory overhead, and factory burden

Activity base under consideration

total volume of goods & services provided by organization. Specify activity base only when it is something other than total output

Discretionary fixed costs (managed fixed costs)

usually arise from annual decisions by management to spend on certain fixed cost items. Ex. advertising, research, public relations, management development programs, internships for students

variable cost

varies, in total, in direct proportion to changes in level of activity Ex. COGS for merchandising company, direct materials, direct labor, variable elements of manufacturing overhead: indirect materials, supplies, power, variable elements of selling & administrative expenses= commissions & shipping costs