14/09/2019

Managerial Accounting
Code: 0502603
Week 2

Introduction to Managerial Accounting

• What will you study on this course?
 Cost Concepts
 Cost behaviour
 Cost-volume-profit analysis
 Budgeting
 Relevant costs for decision making
 Performance measures

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Introduction to Managerial Accounting

• Course ILOs
1. Explain, critically analyze and evaluate the concepts of
cost behavior, cost volume profit analysis, and short-term
decision making, as utilized in management accounting
decisions.
2. Evaluate the use of budgeting, cost control, and
performance measurement as management planning and
decision tools.
3. Apply managerial accounting and its objectives in a way
that demonstrates a clear understanding of ethical
responsibilities.
4. Applying managerial accounting concepts and techniques
to real world examples from the UAE business
environment.

In the previous lecture

• We discussed:
• Managerial and financial accounting
terminologies
• Manufacturing versus non-manufacturing
costs
• Product versus period costs
• Prime and conversion costs

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Classifications of Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

The Product

Nonmanufacturing Costs

Selling Administrative
Costs Costs

Costs necessary to All executive,

secure the order and organizational, and clerical
deliver the product. costs.

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Product Costs Versus Period Costs

Product costs include Period costs include all

direct materials, direct selling costs and
labor, and administrative costs.
manufacturing
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement

Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct Direct Manufacturing
Material Labor Overhead

Prime Conversion
Cost Cost

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This lecture
1. Understand cost behavior patterns including variable
costs, fixed costs, and mixed costs.
2. Analyze a mixed cost using a scattergraph plot and the
high-low method.
3. Prepare income statements for a merchandising
company using the traditional and contribution
formats.
4. Understand the differences between direct and
indirect costs.
5. Understand cost classifications used in making
decisions: differential costs, opportunity costs, and
sunk costs.

1. Understand cost behavior patterns

including variable costs, fixed costs,
and mixed costs.
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 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.
• NOTE: 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.

Fixed Cost
• Fixed costs remain constant, in TOTAL, to the change in the level
of activity.
• 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.

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Fixed Costs and the Relevant Range

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.

Fixed Costs and the Relevant Range

90
Rent Cost in Thousands of

The relevant range

Relevant of activity for a fixed
60 cost is the range of
Dollars

Range activity over which

the graph of the
cost is flat.
30

0
0 1,000 2,000 3,000
Rented Area (Square Feet)

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Cost Classifications for Predicting Cost

Behavior

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

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.

Your turn
• Provide 2 examples for variable costs and fixed
costs in a TV factory.

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Mixed Costs
(also called semivariable costs)
A mixed cost contains both variable and fixed elements.
Consider the example of utility cost.
Y
Total Utility Cost

Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge

Mixed Costs
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
Y vertical intercept of the line).
b = The variable cost per unit of
Total Utility Cost

activity (the slope of the line).

X = The level of activity.

Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge

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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

This lecture
1. Understand cost behavior patterns including variable
costs, fixed costs, and mixed costs.
2. Analyze a mixed cost using a scattergraph plot and the
high-low method.
3. Prepare income statements for a merchandising
company using the traditional and contribution
formats.
4. Understand the differences between direct and
indirect costs.
5. Understand cost classifications used in making
decisions: differential costs, opportunity costs, and
sunk costs.

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Scattergraph Plots – An Example

Assume the following hours of maintenance work and the total maintenance costs for six months.

The Scattergraph Method

Plot the data points on a graph
(Total Cost Y vs. Activity X).

Y Scattergraph Method
$10,000
Total Maintenance Cost

$9,500

$9,000

$8,500

$8,000

$7,500

$7,000
X
400 500 600 700 800 900

Hours of Maintenance

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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.

$2,400
= $6.00/hour
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

The High-Low Method – An Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X

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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

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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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

Exercise 2
• Zerbel Company, a wholesaler of large, custom-built
air conditioning units for commercial buildings, has
noticed considerable fluctuation in its shipping
expense from month to month, as shown below:

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Required
• 1. Prepare a scattergraph using the data given
above. Plot cost on the vertical axis and
activity on the horizontal axis.
• 2. Using the high-low method, estimate the
cost formula for shipping expense.

This lecture
1. Understand cost behavior patterns including variable
costs, fixed costs, and mixed costs.
2. Analyze a mixed cost using a scattergraph plot and the
high-low method.
3. Prepare income statements for a merchandising
company using the traditional and contribution
formats.
4. Understand the differences between direct and
indirect costs.
5. Understand cost classifications used in making
decisions: differential costs, opportunity costs, and
sunk costs.

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The Traditional and Contribution

Formats

Used primarily for Used primarily by

external reporting. management.

This lecture
1. Understand cost behavior patterns including variable
costs, fixed costs, and mixed costs.
2. Analyze a mixed cost using a scattergraph plot and the
high-low method.
3. Prepare income statements for a merchandising
company using the traditional and contribution
formats.
4. Understand the differences between direct and
indirect costs.
5. Understand cost classifications used in making
decisions: differential costs, opportunity costs, and
sunk costs.

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Assigning Costs to Cost Objects

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

This lecture
1. Understand cost behavior patterns including variable
costs, fixed costs, and mixed costs.
2. Analyze a mixed cost using a scattergraph plot and the
high-low method.
3. Prepare income statements for a merchandising
company using the traditional and contribution
formats.
4. Understand the differences between direct and
indirect costs.
5. Understand cost classifications used in making
decisions: differential costs, opportunity costs, and
sunk costs.

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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: Differential cost is:

$2,000 – $1,500 = $500 $300

Opportunity Cost
The potential benefit that is
given up when one alternative
is selected over another.

Example: If you were

not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for
one year is $15,000.

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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

$400 an ounce, but now it is selling for $250 an
ounce. Should you wait for the gold to reach $400 an
ounce before selling it? You may say, “Yes” even
though the $400 purchase is a sunk costs.

End of Lecture

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