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Chapter 1
Managerial
Accounting and
Cost Concepts
Managerial Accounting
Eighteenth edition

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 Needs of Management
Financial accounting is concerned with reporting financial
information to external users, such as stockholders,
creditors, and regulators.
Managerial accounting is concerned with providing
information to internal users within an organization so that
they can formulate plans, control operations, and make
decisions.

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LO
2-1

What is a Cost?

Cost is a sacrifice of resources.

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 Cost Classification
Financial reporting
• Manufacturing (Product) Cost
• Nonmanufacturing (Period) Cost
Assigning costs to cost objects
• Direct Cost
• Indirect Cost
Predicting cost behavior
• Variable Cost
• Fixed Cost
• Mixed Cost
Decision making
• Differential Cost
• Opportunity Cost
• Sunk Cost
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 Predicting cost behaviour için:

Level of activity: Q produced

VC FC

TVC=VC/unit Q total change no change

Produced per unit no change change

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 Classification 1: Financial Reporting
Product costs:
Period costs:
Costs related to
Non-manufacturing
Inventory
costs related to the firm
Costs that are recorded
Costs recognized for financial
as an asset in inventory when
reporting when incurred
incurred and expensed as
Cost of Goods Sold (COGS)when sold

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 Manufacturing Costs

Manufacturing consists of activities and processes that

convert raw materials into finished goods.

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 Direct Material

Cost of raw material that is used to

make, and can be conveniently
traced, to the finished product.
Example:
Example:
Steel
Steelused
usedto
to
manufacture
manufacture
the
theautomobile.
automobile.

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 Direct Labor

Cost of salaries, wages, and fringe

benefits for personnel who work
directly on manufactured products.

Example:
Example:
Wages
Wagespaid
paidto
toan
an
automobile
automobileassembly
assembly
worker.
worker.

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Manufacturing Overhead

All other manufacturing costs

Indirect Indirect Other
Material Labor Costs

Materials used to support the

production process.
Examples: lubricants and
cleaning supplies used in an
automobile assembly plant.

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Manufacturing Overhead

All other manufacturing costs

Indirect Indirect Other
Material Labor Costs

Cost of personnel who do not

work directly on the product.
Examples: maintenance
workers, janitors, and security
guards.

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Manufacturing Overhead

All other manufacturing costs

Indirect Indirect Other
Material Labor Costs

Examples: depreciation on
plant and equipment, property
taxes of plant facility,
insurance, rent, utilities of
plant facility

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 Classifications of Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

The
Product

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 Manufacturing Costs in Financial Statements

Balance Sheet
Inventory accounts for a manufacturer Illustration 1-8

The balance sheet for a merchandising company shows just one category
of inventory- Merchandise Inventory.

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 Manufacturing Product Costs
For manufacturing companies, product costs include:
• Raw materials: include any materials that go into the final
product.
• 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 the customer.
• Finished goods: consist of completed units of product that
have not yet been sold to customers.

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 Manufacturing Costs in Financial Statements

Balance Sheet
Current assets sections of merchandising and manufacturing balance
sheets

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 Question: ABC Company is a manufacturing company that makes picnic tables and
outdoor furniture. Fill in the table below for which and how inventory account(s)
would be affected by the following actions (indicate +/- for the increase or decrease as
a result of the action).

Work In Finished
Action Raw Materials Process Goods
a. Lumber is delivered by the supplier
to the factory, where it is stored
in a materials storeroom until needed.
b. Lumber is taken from the storeroom
to be used for the production of tables.
c. Factory workers cut the lumber for the
tables.
d. Ten tables are completed and moved to
the inventory storage area to await sale.
e. A customer purchases a table and
takes it home.

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 Nonmanufacturing (Period) Costs

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Product vs Period Costs
All Costs

Product Costs Period Costs

Manufacturing Costs Nonmanufacturing Costs
(Go to Balance Sheet before (Go straight to Income Statement)
Income Statement) Advertising

Selling Sales commissions

Direct Materials Expenses
Shipping costs

Direct Labor Executive salaries

Administrative
Expenses Data processing
Manufacturing
Legal costs
Overhead

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 Cost Classifications for Preparing Financial
Statements

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Classification 2: Assigning Costs to Cost Objects

Direct costs Indirect costs

• Costs that can be • Costs that cannot be easily
easily and conveniently and conveniently traced to a
traced to a unit of product unit of product or other cost
or other cost object. object.
• Examples: direct material • Example: manufacturing
and direct labor 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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 Classification 3: 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.

A variable cost per unit is constant.

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 Fixed Cost
A cost that remains constant, in total, regardless of changes
in the level of the activity.

If expressed on a per unit basis, the average fixed cost per

unit varies inversely with changes in activity.

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 Types of Fixed Costs
Committed. Discretionary.
Long term, cannot be May be altered in the short
significantly reduced in the term by current managerial
short term. decisions.

Examples Examples
Examples
Depreciation on Advertising
Advertising and
and
Equipment and Research
Research and
and
Real Estate Taxes Development
Development

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 Fixed Costs and the Relevant Range
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.

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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 Relevant Range: Graphic

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 Comparison of Cost Classifications for
Predicting Cost Behavior
Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost Increase and Variable cost per unit remains
decrease in proportion to constant.
changes in the activity level.
Fixed Total fixed cost is not affected by Fixed cost per unit decreases as
changes in the activity level within the activity level rises and
the relevant range. increases as the activity level falls.

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 Mixed Costs – Part 1
A mixed cost contains both variable and fixed elements.
Consider the example of utility cost.

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 Mixed Costs – Part 2

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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?

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 Cost Classifications for Decision Making

Decisions involve choosing between alternatives. The goal of

making decisions is to identify those costs that are either
relevant or irrelevant to the decision.
To make decisions, it is essential to have a grasp on the
concepts of differential costs and revenues, opportunity
costs, and sunk costs.

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 Differential Cost and Revenue
Differential costs (or incremental costs) are the difference in
cost between any two alternatives.
A difference in revenue between two alternatives is called
differential revenue.
Both are always relevant to decisions.
Differential costs can be either fixed or variable.

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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 found in accounting records, but

must be explicitly considered in every decision.

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 Sunk Costs
Sunk costs have already been incurred and cannot be
changed now or in the future.
These irrelevant costs should be ignored when making
decisions.

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 The Traditional and Contribution Formats

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

Used primarily for Used primarily by

external reporting. 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:

1. Cost–volume–profit analysis (Chapter 5).

2. Segmented reporting of profit data (Chapter 6).
3. Budgeting (Chapter 8).
4. Special decisions such as pricing and make-or-buy
analysis (Chapter 13).

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