Unit 1: Discussion
Impaler_2019
Chap002.pptPowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
Managerial Accounting and Cost Concepts
Chapter 02
Chapter 2: Managerial Accounting and Cost Concepts. In this chapter we explain how managers need to rely on different cost classifications for different purposes. The four main purposes emphasized in this chapter include preparing external financial reports, predicting cost behavior, assigning costs to cost objects, and decision making.
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The Product
Classifications of Manufacturing Costs
Manufacturing costs are usually grouped into three main categories: direct materials, direct labor, and manufacturing overhead. These costs are incurred to make a product.
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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
Direct materials are raw materials that become an integral part of the finished product and whose costs can be 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.
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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
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.
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Manufacturing Overhead
Manufacturing costs that cannot be easily traced directly to specific units produced.
Examples: Indirect materials and indirect labor
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. It includes indirect labor costs that cannot be 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, etc.
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Nonmanufacturing 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. Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses.
Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization. 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.
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Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing overhead.
Period costs include all selling costs and administrative costs.
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. More specifically, 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 in which all manufacturing costs are treated as product costs.
Period costs include all selling costs 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.
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Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct
Material
Direct
Labor
Manufacturing
Overhead
Two more cost categories are often used in discussions of manufacturing costs—prime cost and conversion cost. Prime cost is the sum of direct materials cost and direct labor cost. Conversion cost is the sum of direct labor cost and manufacturing overhead cost. The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product.
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Variable Cost
Your total texting bill is based on how many texts you send.
A variable cost varies, in total, in direct proportion to changes in the level of activity. For example, if you don’t have a texting plan on your cell phone, text messaging costs 5 cents per text. Your total texting bill increases with the number of texts you send.
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Variable Cost Per Unit
The cost per text sent is constant at
5 cents per text message.
Although variable costs change in total as the activity level rises and falls, variable cost per unit is constant. For example, the cost per text message sent is constant at 5 cents per text.
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The Activity Base (Cost Driver)
A measure of what causes the incurrence of a variable cost
Units
produced
Miles driven
Machine hours
Labor hours
An activity base (also called a cost driver) is a measure of what causes the incurrence of variable costs. As the level of the activity base increases, the total variable cost increases proportionally.
Units produced (or sold) is not the only activity base within companies. A cost can be considered variable if it varies with activity bases such as miles driven, machine hours, or labor hours.
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Fixed Cost
Your monthly contract fee for your cell phone is fixed for the number of monthly minutes in your contract. The monthly contract fee does not change based on the number of calls you make.
A fixed cost is constant within the relevant range. In other words, fixed costs do not change for changes in activity that fall within the “relevant range.” For example, your monthly contract fee for your cell phone is a fixed amount for a certain number of minutes. The monthly contract fee does not change based on the number of calls you make.
Of course, if you go over your monthly minutes allotment, you have exceed the relevant range for your monthly contract and will be charged above and beyond your monthly contract fee.
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Fixed Cost Per Unit
Within the monthly contract allotment, the average fixed cost per cell phone call made decreases as more calls are made.
However, when expressed on a per unit basis, a fixed cost is inversely related to activity—the per unit cost decreases when activity rises and increases when activity falls. For example, the average fixed cost per cell phone call made decreases as more calls are made in the month.
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Examples
Advertising and Research and Development
Examples
Depreciation on Buildings and Equipment and 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.
One type of fixed cost is known as committed fixed costs. These are long-term fixed costs that cannot be significantly reduced in the short term. Some examples include depreciation on buildings and equipment and real estate taxes on factory property.
Another type of fixed cost is known as discretionary fixed costs. These fixed costs may be altered in the short-term by current management decisions. Some examples of discretionary fixed costs include advertising and research and development costs.
A cost may be discretionary or committed depending upon management’s strategy. For example, some construction companies may layoff workers during months with minimal customer demand. However, other construction companies may opt to retain their workers all year.
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Activity
Total Cost
Economist’s
Curvilinear Cost Function
The Linearity Assumption and the Relevant Range
Economists correctly point out that many costs which accountants classify as variable costs actually behave in a curvilinear fashion.
Nonetheless, within a narrow band of activity known as the relevant range, a curvilinear cost can be satisfactorily approximated by a straight line.
The relevant range is that range of activity within which the assumptions made about cost behavior are valid.
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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.
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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Mixed Costs
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
Total Utility Cost
Total mixed cost
Sheet1
| 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 mixed cost line can be expressed with the equation Y = a + bX. This equation should look familiar, from your algebra and statistics classes.
In the equation, Y is the total mixed cost; a is the total fixed cost (or the vertical intercept of the line); b is the variable cost per unit of activity (or the slope of the line), and X is the actual level of activity.
In our utility example, Y is the total mixed cost; a is the total fixed monthly utility charge; b is the cost per kilowatt hour consumed, and X is the number of kilowatt hours consumed.
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End of Chapter 02
End of Chapter 2.
Chapter 2: Managerial Accounting and Cost Concepts. In this chapter we explain how managers need to rely on different cost classifications for different purposes. The four main purposes emphasized in this chapter include preparing external financial reports, predicting cost behavior, assigning costs to cost objects, and decision making.
Manufacturing costs are usually grouped into three main categories: direct materials, direct labor, and manufacturing overhead. These costs are incurred to make a product.
Direct materials are raw materials that become an integral part of the finished product and whose costs can be 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.
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.
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. It includes indirect labor costs that cannot be 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, etc.
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. Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses.
Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization. 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.
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. More specifically, 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 in which all manufacturing costs are treated as product costs.
Period costs include all selling costs 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.
Two more cost categories are often used in discussions of manufacturing costs—prime cost and conversion cost. Prime cost is the sum of direct materials cost and direct labor cost. Conversion cost is the sum of direct labor cost and manufacturing overhead cost. The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product.
A variable cost varies, in total, in direct proportion to changes in the level of activity. For example, if you don’t have a texting plan on your cell phone, text messaging costs 5 cents per text. Your total texting bill increases with the number of texts you send.
Although variable costs change in total as the activity level rises and falls, variable cost per unit is constant. For example, the cost per text message sent is constant at 5 cents per text.
An activity base (also called a cost driver) is a measure of what causes the incurrence of variable costs. As the level of the activity base increases, the total variable cost increases proportionally.
Units produced (or sold) is not the only activity base within companies. A cost can be considered variable if it varies with activity bases such as miles driven, machine hours, or labor hours.
A fixed cost is constant within the relevant range. In other words, fixed costs do not change for changes in activity that fall within the “relevant range.” For example, your monthly contract fee for your cell phone is a fixed amount for a certain number of minutes. The monthly contract fee does not change based on the number of calls you make.
Of course, if you go over your monthly minutes allotment, you have exceed the relevant range for your monthly contract and will be charged above and beyond your monthly contract fee.
However, when expressed on a per unit basis, a fixed cost is inversely related to activity—the per unit cost decreases when activity rises and increases when activity falls. For example, the average fixed cost per cell phone call made decreases as more calls are made in the month.
One type of fixed cost is known as committed fixed costs. These are long-term fixed costs that cannot be significantly reduced in the short term. Some examples include depreciation on buildings and equipment and real estate taxes on factory property.
Another type of fixed cost is known as discretionary fixed costs. These fixed costs may be altered in the short-term by current management decisions. Some examples of discretionary fixed costs include advertising and research and development costs.
A cost may be discretionary or committed depending upon management’s strategy. For example, some construction companies may layoff workers during months with minimal customer demand. However, other construction companies may opt to retain their workers all year.
Economists correctly point out that many costs which accountants classify as variable costs actually behave in a curvilinear fashion.
Nonetheless, within a narrow band of activity known as the relevant range, a curvilinear cost can be satisfactorily approximated by a straight line.
The relevant range is that range of activity within which the assumptions made about cost behavior are valid.
The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat.
The mixed cost line can be expressed with the equation Y = a + bX. This equation should look familiar, from your algebra and statistics classes.
In the equation, Y is the total mixed cost; a is the total fixed cost (or the vertical intercept of the line); b is the variable cost per unit of activity (or the slope of the line), and X is the actual level of activity.
In our utility example, Y is the total mixed cost; a is the total fixed monthly utility charge; b is the cost per kilowatt hour consumed, and X is the number of kilowatt hours consumed.
End of Chapter 2.
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.
