Chapter 1 Managerial Accounting and Cost Concepts​

Product Costs

include direct materials, direct labor, and manufacturing overhead

indirect cost

a cost that cannot be easily and conveniently traced to a specified cost object. IE. a Campbell Soup factory may produce dozens of varieties of canned soups. The factory manager's salary would be an indirect cost of a particular variety such as chicken noodle soup

Direct Labor

consists of labor costs that can be easily traced to individual units of product. Ex: Wages paid to automobile assembly workers

Direct Labor

consists of labor costs that can be easily traced to individual units of product. sometimes called touch labor because direct labor workers typically touch the product while it is being made

work in process

consists of units of product that are only partially complete and will require further work before they are ready for sale to customer

Conversion Cost

direct labor + manufacturing overhead

prime cost=

direct materials + direct labor

product cost=

direct materials + direct labor + manufacturing overhead

variable manufacturing cost=

direct materials + direct labor + variable manufacturing overhead

Administrative costs

include all costs associated with the general management of an organization rather than with manufacturing or selling -examples of administrative costs include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall, general administration of the organization as a whole. -can be either direct or indirect costs -example, salary of an accounting manager in charge of accounts receivable collections in the East region is a direct cost of that region, whereas the salary of a chief financial officer who oversees all of a company's regions is an indirect cost with respect to individual regions

Manufacturing overhead

includes all manufacturing costs except direct materials and labor. These costs cannot be easily traced to finished products. includes indirect materials that cannot be easily or conveniently traced to a single specific units of products, includes indirect labor that cannot be easily or conveniently traced to a single specific units of product.

cost behavior

refers to how a cost reacts to changes in the level of activity. As the activity levels rises and falls, a particular cost may rise and fall as well -or it may remain constant. For planning purposes, a manager must be able to anticipate which of these will happen; and if a cost can be expected to change, the manager must be able to anticipate which of these will happen; and if a cost can be expected to change, the manager must be able to estimate how much it will change. To help make such distinctions, cost are often categorized as variable, fixed or mixed.

conversion cost

refers to the sum of direct labor and manufacturing overhead. The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert direct materials into finished products.

opportunity cost

the potential benefit that is given up when one alternative is selected over another. -costs that must be explicitly considered in every decision a manager makes.

Indirect Costs

-costs that cannot be easily and conveniently traced to a unit of product or other costs objects. ex: manufacturing overhead

product costs include

-direct materials -direct labor -manufacturing overhead

manufacturing companies separate their manufacturing costs into two direct cost categories

-direct materials and direct labor -one indirect cost category, manufacturing overhead

Common Costs

-indirect costs incurred to support a number of cost objects. These costs cannot be traced to any individual cost object.

prepare a traditional income statement

1. sales = number of units sold x selling price per unit 2. cost of goods sold= beginning inventory + merchandise purchase - less ending inventory 3. Gross margin= sales - cost of goods sold SELLING AND ADMINISTRATIVE EXPENSES 4. selling expenses= (variable selling expense per unit x number of units sold) + selling fixed expenses 5.administrative expenses = (variable administrative expense per unit x units sold) + fixed administrative expenses

Conversion Costs

-Direct Labor -Manufacturing overhead

variable cost

-in total total variable cost increases and decreases in proportion to changes in the activity level -per unit variable cost per unit remains constant

Administrative costs

-the costs associated with the general management of an organization rather with manufacturing or selling Administrative costs can be either direct or indirect costs

variable cost

-varies, in total, in direct proportion to changes in the level of activity. -Common examples of variable costs include cost of goods sold for a merchandising company, direct materials, direct labor, variable elements of manufacturing overhead, such as indirect materials, supplies, and power, and variable elements of selling and administrative expenses such as commissions and shipping costs.

cost object

is anything for which cost data are desired-including products, customers, and organizational subunits.

Managerial Accounting

is concerned with providing information to managers within an organization so that they can formulate plans, control operations, and make decisions.​

Prime Costs

-Direct Materials -Direct Labor

Assigning Costs to Cost Objects​

-Direct costs -Indirect costs -Common Costs

nonmanufacturing costs

-Selling costs -Administrative Costs

incremental cost

-an increase in cost between two alternatives also known as decremental cost whereas decreases in cost

Selling Costs

-costs incurred to secure customer orders and get the finished product to the customers. Selling costs can be direct or indirect costs.

Purposes 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

total fixed cost=

fixed manufacturing overhead + fixed selling expense + fixed administrative

Prime costs/two direct manufacturing cost

is the sum of direct materials cost and direct labor cost

Non-manufacturing costs are also called

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

Manufacturing Overhead

the third manufacturing cost category, includes all manufacturing costs except direct materials and direct labor. For example, manufacturing overhead includes a portion of raw materials known as indirect materials, as well as indirect labor.

step-variable costs

-Cost behavior patterns such as salaried employees. -can be adjusted quickly as conditions change -the width of the step for step-variable costs is generally so narrow that these costs can be treated essentially as variable costs for most purposes. -the width of the steps for fixed costs, on the other hand, is so wide that these costs should be treated as entirely fixed within the relevant range

Manufacturing Overhead Examples

-Depreciation of manufacturing equipment -Utility Costs -Property Taxes -Insurance Premiums incurred to operate a manufacturing facility -Only those indirect costs associated with operating the factory included

sunk cost

-a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Because sunk costs cannot be changed by any decision, they are not differential costs. And because only differential costs are relevant in a decision, sunk cost should always be ignored.

differential cost

-a future cost that differs between any two alternatives -always relevant costs -future revenue that differers between any two alternatives is known as differential revenues -differential revenue is an example of relevant benefit -any future cost or benefit that does not differ between alternatives is irrelevant and should be ignored -can be fixed or variable

direct or indirect

-a particular cost may be direct or indirect, depending on the cost object. IE. While the Campbell Soup Factory manager's salary is an indirect cost of manufacturing chicken noodle soup, it is a direct cost of the manufacturing division. In the first case, the cost object is chicken noodle soup. In the second case, the cost object is the entire manufacturing division

Manufacturing Overhead

-also includes other indirect costs that cannot be readily traced to finished products such as depreciation of manufacturing equipment and the utility costs, property taxes, and insurance premiums incurred to operate a manufacturing facility. -only those indirect costs associated with operating the factory are included in manufacturing overhead

Direct Costs

-costs that can be easily and conveniently traced to a unit of product or other cost object. ex: direct materials and direct labor

fixed cost

-in total total fixed cost is not affected by changes in the activity level within the relevant range -per unit fixed cost per unit decreases as the activity level rises and increases as the activity level falls

product costs

-include all costs involved in acquiring or making a product. -costs "attach" to a unit of product as it is purchased or manufactured and they stay attached to each unit of product as long as it remains in inventory awaiting sales.

fixed costs

-is a cost that remains constant, in total, regardless of changes in the level of activity. -Manufacturing overhead usually includes various fixed costs such as depreciation, insurance, property taxes, rent, and supervisory salaries. Similarly, selling and administrative costs often include fixed costs such as administrative salaries, advertising and depreciation of non-manufacturing assets. Unlike variable costs, fixed costs are not affected by changes in activity. Consequently, as the activity level rises and falls, total fixed costs remain constant unless influenced by some outside force, such as a landlord increasing your monthly rent.

raw materials

-materials that go into the final product are called raw materials. -term is misleading because it seems to imply unprocessed natural resources like wood pulp or iron ore. Actually, raw materials refer to any materials that are used in the final product; and the finished product of one company can become the raw materials of another company

Period costs

-period costs are expensed when incurred/when they occur -period costs do not flow through the inventory accounts

manufacturer's product costs flow through three inventory accounts on the balance sheet

-raw materials -work in process -finished goods prior to being recorded in cost of goods sold on the income statement

committed fixed costs

-represent organizational investments with a multiyear planning horizon that can't be significantly reduced even for short periods of time without making fundamental changes. -examples: include investments in facilities and equipment, as well as real estate taxes, insurance premiums, and salaries of top management. -committed fixed costs remain largely unchanged in the short term because the costs of restoring them later are likely to be far greater than any short-run savings that might be realized

when direct materials are used in production

-their costs are transferred from Raw materials to work in process -direct labor and manufacturing overhead costs are added to Work in Process to convert direct materials into finished goods -once units of product are completed, their costs are transferred from Work in Process to Finished Goods. -when a manufacturer sells its finished goods to customers, the costs are transferred from Finished Goods to Cost of Goods sold

discretionary fixed costs/ managed fixed costs

-usually arise from annual decisions by management to spend on certain fixed cost items. -examples include advertising, research, public relations, management development programs, and internships for students -discretionary fixed costs can be cut for short periods of time with minimal damage to the long-run goals of the organizations

Classifications of Manufacturing Costs

1. Direct Materials 2. Direct Labor 3. Manufacturing Overhead

Non-manufacturing costs are often divided into two categories

1. selling costs 2. administrative costs

direct cost

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

common cost

a cost that is incurred to support a number of cost objects but cannot be traced to them individually, is a type of indirect cost

activity base

a measure of whatever causes the incurrence of a variable cost. An activity base is sometimes referred to as a cost driver. Some of the most common activity bases are direct labor-hours, machine-hours, units produced, and units sold

Period Costs

are all the costs that are not product costs. All selling and administrative expenses are treated as period costs. for example, sales commissions, advertising, executive salaries, public relations, and the rental costs of administrative offices are all period costs. -Period costs are not included as part of the cost of either purchased or manufactured goods; instead, period costs are expensed on the income statement in the period in which they are incurred using the usual rules of accrual accounting.

Direct Materials

are raw materials that become an integral part of the product and that can be conveniently traced directly to it. ex: A radio installed in an automobile

Indirect Materials

are raw materials, such as the solder used to make electrical connections in a Samsung HDTV and the glue used to assemble an Ethan Allen chair, whose costs cannot be easily or conveniently traced to finished products

y=ax+b

because the variable cost per unit equals the slope of the straight line, the steeper the slope, the higher the variable cost per unit y= total mixed cost 25,000 = total fixed cost + 3,000x = variable cost per unit of activity

Total Variable Cost (TVC)

changes as the activity level changes, it is important to note that a variable cost is constant if expressed on a per unit basis. For example, the per unit cost of the meals remains constant at $30 even though the total cost of the meals increases and decreases with activity.

fixed costs can be viewed as either

committed or discretionary

costs that are shared by multiple cost objects in a company are known as

common costs

finished goods

consist of completed units of product that have not yet been sold to customers

mixed cost

contains both variable and fixed cost elements. Mixed costs are also known as semi-variable costs.

costs are recognized as

expenses on the income statement in the period that benefits from the cost. For example, if a company pays for liability insurance in advance for two years, the entire amount is not considered an expense of the year in which the payment is made. instead, one-half of the cost would be recognized as an expense each year. -The reason is that both years-not just the first year- benefit from the insurance payment. The unexpensed portion of the insurance payment is carried on the balance sheet as an asset called prepaid insurance

selling costs

include all costs that are incurred to secure customer orders and get the finished product to the customer. -These costs are sometimes are called order-getting and order-filling costs. -Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouse. -can be either direct or indirect costs -the cost of an advertising campaign dedicated to one specific product is a direct cost of that product, whereas the salary of a marketing manager who oversees numerous products is an indirect cost with respect to individual products.

raw materials

include any materials that go into the final product

Financial Accounting

is concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators.​

Relevant Range

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

The Linearity Assumption

management accountants ordinarily assume that costs are strictly linear; that is, the relation between cost on the one hand and activity on the other hand and activity on the other can be represented by a straight line within a narrow band of activity known as the relevant range.

Indirect Labor

refers to employees such as janitors, supervisors, materials handlers, maintenance workers, and night security guards, that play an essential role in running a manufacturing facility; however, the cost of compensating these people cannot be easily/ conveniently traced to specific units of product

Direct Materials

refers to raw materials that become an integral part of the finished product and whose costs can be conveniently traced to the finished product

period cost=

selling expense + administrative expense

matching principle is based on

the accrual concept that costs incurred to generate a particular revenue should be recognized. -meaning that if a cost is incurred to acquire or make something that will eventually be sold, then the cost should be recognized as an expense only when the sale takes place -that is when the benefit occurs -costs are called product costs

cost structure

the relative proportion of each type of cost in an organization

General rule about fixed costs

we caution against expressing fixed costs on an average per unit basis in internal reports because it creates the false impression that fixed costs are like variable costs and that total fixed costs actually change as the level of activity changes

inventoriable/product costs

when units of product are sold, their costs are released from inventory as expenses typically called costs of goods sold and matched against sales on the income statement. Because product costs are initially assigned to inventories.

y=a + bx

y=the total mixed cost a=the total fixed cost (the vertical intercept of the time) b= X=the level of activity