accounting
Managerial Accounting and Cost Concepts
Chapter 1
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 by McGraw-Hill Education. All rights reserved.
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Summary of the Types of Cost Classifications
Assigning Costs to Cost Objects
Predicting Cost Behavior
Financial Reporting
Making Business Decisions
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Learning Objective 1-1
Understand cost classifications used for assigning costs to cost objects: direct costs and indirect costs.
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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
Common costs
Indirect costs incurred to support a number of cost objects. These costs cannot be traced to any individual cost object.
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Learning Objective 1-2
Identify and give examples of each of the three basic manufacturing cost categories.
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The Product
Direct Materials
Direct Labor
Manufacturing Overhead
Classifications of Manufacturing Costs
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Direct Materials
Raw materials that become an integral part of the product and that can be conveniently traced directly to it.
Example: A radio installed in an automobile
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Direct Labor
Those labor costs that can be easily traced to individual units of product.
Example: Wages paid to automobile assembly workers
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Manufacturing Overhead
Manufacturing costs that cannot be easily traced directly to specific units produced.
Examples: Indirect materials and indirect labor
Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors, and security guards.
Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.
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Nonmanufacturing Costs
Selling Costs
Costs necessary to secure the order and deliver the product. Selling costs can be either direct or indirect costs.
Administrative Costs
All executive, organizational, and clerical costs. Administrative costs can be either direct or indirect costs.
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Learning Objective 1-3
Understand cost classifications used to prepare financial statements: product costs and period costs.
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Cost Classifications for Preparing Financial Statements
Product costs include direct materials, direct labor, and manufacturing overhead.
Period costs include all selling costs and administrative costs.
Inventory
Cost of Good Sold
Balance Sheet
Income Statement
Sale
Expense
Income Statement
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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.
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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.
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Prime Costs and Conversion Costs
Manufacturing costs are often classified as follows:
Direct Material
Direct Labor
Manufacturing Overhead
Prime Cost
Conversion Cost
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Learning Objective 1-4
Understand cost classifications used to predict cost behavior: variable costs, fixed costs, and mixed costs.
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Cost Classifications for Predicting Cost Behavior
Cost behavior refers to how a cost will react to changes in the level of activity. The most common classifications are:
Variable costs.
Fixed costs.
Mixed costs.
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Variable Cost
A cost that varies, in total, in direct proportion to changes in the level of activity. Your total texting bill may be based on how many texts you send.
Number of Texts Sent
Total Texting Bill
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Variable Cost Per Unit
However, variable cost per unit is constant. The cost per text sent may be constant at 5 cents per text message.
Number of Texts Sent
Cost Per Text Sent
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The Activity Base (Cost Driver)
A measure of what causes the incurrence of a variable cost
Labor hours
Miles driven
Units produced
Machine hours
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Fixed Cost
A cost that remains constant, in total, regardless of changes in the level of the activity. Your monthly contract fee for your cell phone may be fixed for the number of monthly minutes in your contract.
Number of Minutes Used Within Monthly Plan
Monthly Cell Phone Contract Fee
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Fixed Cost Per Unit
However, if expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity. The average fixed cost per cell phone call made decreases as more calls are made.
Number of Minutes Used Within Monthly Plan
Monthly Cell Phone Contract Fee
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Examples
Advertising
Research and Development
Examples
Depreciation on Buildings Equipment
Real Estate Taxes
Types of Fixed Costs
Discretionary
May be altered in the short term by current managerial decisions
Committed
Long-term, cannot be significantly reduced in the short term.
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Relevant Range
A straight line closely approximates a curvilinear variable cost line within the relevant range.
Activity
Total Cost
Economist’s Curvilinear Cost Function
The Linearity Assumption and the Relevant Range
Accountant’s Straight-Line Approximation (constant unit variable cost)
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Fixed Costs and the Relevant Range
Fixed costs would increase in a step fashion at a rate of $30,000 for each additional 1,000 square feet.
The relevant range of activity pertains to fixed cost as well as variable costs. For example, assume office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet.
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Rent Cost in Thousands of Dollars
0 1,000 2,000 3,000 Rented Area (Square Feet)
0
30
60
Fixed Costs and the Relevant Range
90
Relevant Range
The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat.
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Cost Classifications for Predicting Cost Behavior
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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.
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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.
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Fixed Monthly Utility Charge
Variable Cost per KW
Activity (Kilowatt Hours)
Total Utility Cost
X
Y
A mixed cost contains both variable and fixed elements. Consider the example of utility cost.
Mixed Costs
Total mixed cost
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Mixed Costs
Fixed Monthly Utility Charge
Variable Cost per KW
Activity (Kilowatt Hours)
Total Utility Cost
X
Y
Total mixed cost
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Mixed Costs – An Example
If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y =
$100
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Analysis of Mixed Costs
In account analysis, each account is
classified as either variable or fixed based
on the analyst’s knowledge of how
the account behaves.
The engineering approach classifies costs based upon an industrial engineer’s evaluation of production methods, and material, labor, and overhead requirements.
Account Analysis and the Engineering Approach
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Learning Objective 1-5
Analyze a mixed cost using a scattergraph plot and the high-low method.
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Scattergraph Plots – An Example
Assume the following hours of maintenance work and the total maintenance costs for six months.
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Plot the data points on a graph (Total Cost Y “dependent variable” vs. Activity X “independent variable”).
The Scattergraph Method
X
Y
Hours of Maintenance
Total Maintenance Cost
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Scattergraph Method
Maintenance Cost 625 450 700 550 775 850 7950 7400 8275 7625 9100 9800
The High-Low Method – An Example
The variable cost per hour of maintenance is equal to the change in cost divided by the change in hours.
= $6.00/hour
$2,400 400
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The High-Low Method – An Example
Total Fixed Cost = Total Cost – Total Variable Cost
Total Fixed Cost = $9,800 – ($6/hour × 850 hours)
Total Fixed Cost = $9,800 – $5,100
Total Fixed Cost = $4,700
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The High-Low Method – An Example
Y = $4,700 + $6.00X
The Cost Equation for Maintenance
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Quick Check
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
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Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
Quick Check
$4,000 ÷ 40,000 units = $0.10 per unit
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Quick Check
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
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Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
Quick Check
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Least-Squares Regression Method
A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between the X and Y variables.
This method uses all of the data points to estimate the fixed and variable cost components of a mixed cost.
The goal of this method is to fit a straight line to the data that minimizes the sum of the squared errors.
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Least-Squares Regression Method
Software can be used to fit a regression line through the data points.
The cost analysis objective is the same: Y = a + bX
Least-squares regression also provides a statistic, called the R2, which is a measure of the goodness of fit of the regression line to the data points.
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Comparing Results From the Two Methods
The two methods just discussed provide different estimates of the fixed and variable cost components of a mixed cost.
This is to be expected because each method uses differing amounts of the data points to provide estimates.
Least-squares regression provides the most accurate estimate because it uses all the data points.
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Learning Objective 1-6
Prepare income statements for a merchandising company using the traditional and contribution formats.
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The Traditional and Contribution Formats
Used primarily for external reporting.
Used primarily by management.
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Uses of the Contribution Format
The contribution income statement format is used as an internal planning and decision-making tool. We will use this approach for:
Cost-volume-profit analysis (Chapter 5).
Budgeting (Chapter 7).
Segmented reporting of profit data (Chapter 6).
Special decisions such as pricing and make-or-buy analysis (Chapter 10).
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Learning Objective 1-7
Understand cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.
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Every decision involves a choice between at least two alternatives.
Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits can and should be ignored as irrelevant.
Cost Classifications for Decision Making
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Differential Cost and Revenue
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 revenue is:
$2,000 – $1,500 = $500
Differential cost is:
$300
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Opportunity Cost
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.
What are the opportunity costs you incur to attend this class?
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Sunk Costs
Sunk costs have already been incurred and cannot be changed now or in the future. These costs should be ignored when making decisions.
Example: Suppose you had purchased gold for $1,100 an ounce, but now it is selling for $950 an ounce. Should you wait for the gold to reach $1,100 an ounce before selling it? You may say, “Yes” even though the $1,100 purchase is a sunk cost.
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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.
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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.
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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.
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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.
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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.
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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.
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End of Chapter 1
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Behavior of Cost (within the relevant range)
CostIn TotalPer Unit
VariableTotal variable cost IncreaseVariable cost per unit
and decrease in proportionremains constant.
to changes in the activity level.
FixedTotal fixed cost is not affectedFixed cost per unit decreases
by changes in the activityas the activity level rises and
level within the relevant range.increases as the activity level falls.
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| Behavior of Cost (within the relevant range) | ||||
| Cost | In Total | Per Unit | ||
| Variable | Total variable cost Increase | Variable cost per unit | ||
| and decrease in proportion | remains constant. | |||
| to changes in the activity level. | ||||
| Fixed | Total fixed cost is not affected | Fixed cost per unit decreases | ||
| by changes in the activity | as the activity level rises and | |||
| level within the relevant range. | increases as the activity level falls. |
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The total mixed cost line can be expressed
as an equation: Y = a + bX
Where: Y=The total mixed cost.
a=The total fixed cost (the
vertical intercept of the line).
b=The variable cost per unit of
activity (the slope of the line).
X=The level of activity.
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| The total mixed cost line can be expressed | |||||
| as an equation: Y = a + bX | |||||
| Where: | Y | = | The total mixed cost. | ||
| a | = | The total fixed cost (the | |||
| vertical intercept of the line). | |||||
| b | = | The variable cost per unit of | |||
| activity (the slope of the line). | |||||
| X | = | The level of activity. |
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Total cost =Total fixed cost +
Total variable cost
$14,000=Total fixed cost +
($0.10 × 120,000 units)
Total fixed cost=$14,000 - $12,000
Total fixed cost =$2,000
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| Total cost | = | Total fixed cost + | ||
| Total variable cost | ||||
| $14,000 | = | Total fixed cost + | ||
| ($0.10 × 120,000 units) | ||||
| Total fixed cost | = | $14,000 - $12,000 | ||
| Total fixed cost | = | $2,000 |
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Comparison of the Contribution Income Statement
with the Traditional Income Statement
Traditional FormatContribution Format
Sales100,000$ Sales100,000$
Cost of goods sold70,000 Variable expenses60,000
Gross margin30,000$ Contribution margin40,000$
Selling & admin. expenses20,000 Fixed expenses30,000
Net operating income10,000$ Net operating income10,000$
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| Comparison of the Contribution Income Statement | |||||||||||
| with the Traditional Income Statement | |||||||||||
| Traditional Format | Contribution Format | ||||||||||
| Sales | $ 100,000 | Sales | $ 100,000 | ||||||||
| Cost of goods sold | 70,000 | Variable expenses | 60,000 | ||||||||
| Gross margin | $ 30,000 | Contribution margin | $ 40,000 | ||||||||
| Selling & admin. expenses | 20,000 | Fixed expenses | 30,000 | ||||||||
| Net operating income | $ 10,000 | Net operating income | $ 10,000 |