Chapter 1 Notes Managerial Accounting and Cost Concepts PDF

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Chapter 1 Managerial Accounting and Cost Concepts  

Financial Accounting – Concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators. Managerial Accounting – Concerned with providing information to managers within an organization so that they can formulate plans, control operations, and make decisions.

Cost Classifications for Assigning Costs to Cost Objects  

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Cost Object – Anything for which cost data are desired – including products, customers, and organizational subunits. Direct Cost o Direct Cost – A cost that can be easily and conveniently traced to a specific cost object.  Examples: Direct material and direct labor. Indirect Cost o Indirect Cost – A cost that cannot be easily and conveniently traced to a specified cost object.  Examples: Manufacturing overhead. o Common Cost – A cost that is incurred to support a number of cost objects but cannot be traced to them individually.  Examples: The factory manager’s salary is a common cost of producing the various products of the factory.

Cost Classifications for Manufacturing Companies 

Manufacturing Costs o Direct Materials:  Raw Materials – Any materials that are used in the final product. The finished product of one company can become the raw materials of another.  Direct Materials – Raw materials that become an integral part of the finished product and whose costs can be conveniently traced to the finished product.  Examples: Electronic components that apple uses in iPhones or the doors that Whirlpool installs on its refrigerators. o Direct Labor:  Direct Labor – Labor costs that can be easily traced to individual units of product.  Examples: Assembly-line workers at Toyota.

Prime Costs = Direct Materials Cost + Direct Labor Cost o Manufacturing Overhead  Manufacturing Overhead – Includes all manufacturing costs except direct materials and direct labor. Includes a portion of raw materials known as indirect materials and indirect labor.  Indirect Materials – Raw materials, such as the solder used to make electrical connections in a TV, whose costs cannot be easily or conveniently traced to finished products.  Indirect Labor – Employees, such as janitors, supervisors, materials handlers, and night security guards that play an essential role in running a manufacturing facility. The cost of compensating these people cannot be easily or conveniently traced to specific units of product. Manufacturing overhead also includes depreciation, property taxes, and  insurance premiums. 

Conversion Cost = Direct Labor + Manufacturing Overhead

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Nonmanufacturing Costs (Also known as SG&A Costs)

o Examples of selling costs:  Advertising  Shipping  Sales travel  Sales commissions  Sales salaries  Costs of finished goods warehouses o Examples of administrative costs:  Executive compensation  General accounting  Secretarial  Public relations

Cost Classifications for Preparing Financial Statements 

Product Costs o Product Costs – Include all costs involved in acquiring or making a product.  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 sale.  Also known as inventoriable costs because they are initially assigned to inventories.  For manufacturing companies, these costs include direct materials, direct labor, and manufacturing overhead and flow through three inventory accounts on the balance sheet including:  Raw Materials  Work in Process – Units of product that are only partially complete and will require further work before they are ready.

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Finished Goods – Completed units of product that have not yet been sold.

Period Costs o Period Costs – All the costs that are not product costs such as selling and administrative expenses. o Period costs are expensed on the income statement in the period in which they are incurred

Cost Classifications for Predicting Cost Behavior  

Cost Behavior – How a cost reacts to changes in the level of activity. Variable Cost o Variable Cost – A cost that varies, in total, in direct proportion to changes in the level of activity.  A variable cost per unit is constant.  Examples: Cost of goods sold for a merchandising company, direct materials and labor, indirect materials, supplies, and power, etc.. o Activity Base – A measure of whatever causes the incurrence of a variable cost.  Sometimes referred to as a cost driver.  Most common activity bases are:  Direct labor hours  Machine hours  Units produced  Units sold  Miles driven

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Fixed Cost o Fixed Cost – A cost that remains constant, in total, regardless of changes in the level of activity.  If expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity. o Types of fixed costs:

o Examples of committed fixed costs:  Investments in facilities and equipment  Real estate taxes  Insurance premiums  Salaries of top management o Examples of discretionary fixed costs:  Advertising  Research  Public relations  Management development programs  Internships for students The Linearity Assumption and the Relevant Range

o Relevant Range – The range of activity within which the assumption that cost behavior is strictly linear is reasonably valid.

o 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.

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Mixed Costs o Mixed Costs – Contain both variable and fixed costs elements; also known as semi variable costs. o Example: Company incurs a mixed cost of fees paid to the state. There is a license fee of $25,000 per year plus $3 per rafting party.

o Total mixed cost line can be expressed as an equation:

Y = a + bX    

Y = Total mixed cost a = Total fixed cost (vertical intercept of the line) b = Variable cost per unit of activity (slope of the line) X = The level of activity

Cost Classifications for Decision Making 

Differential Cost and Revenue o Differential Cost (Incremental Cost) – A future cost that differs between any two alternatives.

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 Includes both increases and decreases between alternatives.  Always relevant costs.  Can be either fixed or variable. o Differential Revenue – Future revenue that differs between any two alternatives. Sunk Cost and Opportunity Cost o Sunk Cost – A cost that has already been incurred and that cannot be changed by any decision made now or in the future.  These costs should be ignored when making decisions. o Opportunity Cost – The potential benefit that is given up when one alternative is selected over another.  These costs are not usually found in accounting records but must be explicitly considered in every decision.

Using Different Cost Classifications for Different Purposes  

The Traditional Format Income Statement o Prepared primarily for external reporting purposes. The Contribution Format Income Statement o Prepared for internal management purposes. o Contribution Approach – An income statement format that organizes costs by their behavior. Costs are separated into variable and fixed categories rather than being separated into product and period costs for external reporting purposes.  This aids in planning, controlling, and decision making. o Contribution Margin – The amount remaining from sales revenue after all variable expenses have been deducted.

Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory...