Managerial Accounting

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1-Direct versus Indirect Costs

Direct Costs Indirect Costs

Costs that can be easily and

Costs that cannot be easily and conveniently
conveniently traced to a unit of product
traced to a unit of product or other cost object.
or other cost object.

Example: At California Pizza Kitchen,

Example: For California Pizza Kitchen,
indirect costs include items such as
direct costs would include the costs of
depreciation on the ovens used to bake the
materials and labor that can be traced
pizzas as well as the costs of utilities,
directly to each pizza produced.
advertising, and supervision.
2-Variable versus Fixed Costs

Variable costs Fixed costs

A variable cost changes in direct

A fixed cost is not immediately affected by
proportion to changes in the cost-driver
changes in the cost-driver level.
level.

Think of variable costs on a per-unit

Think of fixed costs on a total-cost basis
basis.

The per-unit variable cost remains

Total fixed costs remain unchanged
unchanged regardless of changes in the
regardless of changes in the cost-driver.
cost-driver.

Mixed Costs
Total mixed costs increase as activity increases. Per unit mixed costs decrease as
activity increases.
The High-Low Method

Change in cost $31,000  $18,500 $12,500

   $0.25 per unit
Change in units 67,500  17,500 50,000
Total cost  Fixed cost   Variable cost per unit × Units 
$31, 000  Fixed cost   $0.25 per unit  67,500 units 
$31, 000  Fixed cost  $16, 875
$14 , 125  Fixed cost
Total cost = $14,125 + $0.25 per unit produced
3- Manufacturing versus Nonmanufacturing Costs
 Manufacturing costs (Product)
Include all costs incurred to produce the physical product.
It includes:
- Direct Materials
Are major material inputs that can be physically and conveniently traced directly to
the final product?
Examples:
Glass windows installed in an automobile - Sauce, cheese, and meat for a pizza
- Direct Labor
Is the cost of labor that can be physically and conveniently traced to the final
product.
Examples:
Wages paid to automobile assembly workers- Wages paid to employees on the
pizza production line
- Manufacturing Overhead
Includes all costs other than direct materials and direct labor that must be incurred
to manufacture a product.
Manufacturing overhead costs include the following costs at the manufacturing
facility: maintenance and repairs on production equipment, utilities, property taxes,
depreciation, insurance, and salaries for supervisors, janitors, and security guards.
 Nonmanufacturing Costs (Period)

- Marketing or Selling Costs

Costs necessary to get the order and deliver the product
- General and Administrative Costs
All executive, organizational, and clerical costs

4. Relevant versus Irrelevant Costs (Decision Making)

A relevant cost has the potential to influence a decision,
For a cost to be relevant, it must:
1- Differ between the decision alternatives. Costs that differ between the
alternatives are called incremental or differential costs.
2- Be incurred in the future rather than the past (Avoidable): can be eliminated,
in whole or in part, by choosing one alternative over another.
 The Traditional and Contribution Formats

Contribution Approach Traditional Approach

Sales Sales
Less: Variable Costs Less: COGS (Product Cost or Manufacturing
costs)
Contribution Margin Less: operating (period)
Less: Fixed Costs Selling exp
Net Income Administrative exp
Net income

- Prim cost : direct material + direct labor

- Conversion cost: direct labor + manufacturing overhead (var. or fix.)
- contribution margin: sales – variable expenses
- unit contribution margin: sales price – variable cost/ unit
- contribution margin ratio %: contribution margin / sales * 100 or
- contribution margin ratio: unit contribution margin / unit sales price
- gross margin: Sales – Manufacturing costs (COGS)
- If the sales volume increases with no change in total fixed expenses, we can
calculate it with= ( units increase x unit contribution margin )
 Break Even Analysis

 Breakeven point (BEP) =

To find the break-even point, we simply set the profit equation equal to
zero, and solve for the quantity of units (Q).

1- Total revenue = Total cost

(Number of unit x unit price) (Variable + fixed cost)

2- Total revenue – variable cost = fixed cost

3- Total sales revenue − Total variable cost − Total fixed costs = Profit
(Unit price × Q) − (Unit variable costs × Q) − Total fixed costs = Profit
Q = Quantity of unit sold
($2.50× Q) − ($1.00 × Q) − $12,000 = 0
$1.50Q = $12,000
Q = $12,000 ÷ $1.50
Q = 8,000 units
{8000x2.5} – {8000x1}=12000-12000=0

4- BEP per unit = Total Fixed Cost = 12000

= 8000 units
CM/unit 1.5

5- Break-Even Sales ($) = Break-Even Units × Unit Sales Price

Break-Even Sales = 8,000 cups × $2.50 = $20,000

6- Or Break-Even Sales ($) = Total Fixed Costs

Contribution Margin Ratio
Contribution Margin Ratio= $1.5/2.5=0.6 CM / unit price sales
Break even in Sales dollars= 12,000= $20,000
CM/SP= 0.6
 Target Profit Analysis
Assume that the target profit was $18,000.

1- Target Profit Analysis

(Unit price × Q) − (Unit variable costs × Q) − Total fixed costs = Profit
($2.50 × Q) − ($1.00 × Q) − $12,000 = $18,000
$1.50 Q = $30,000
Q = 20,000 units
2- Units to achieve a target profit = Total Fixed Cost + Target Profit
Contribution Margin /Unit
= 12000+18000
1.5
= 20,000 units
Dollar sales to achieve a target profit= 20,000 x SP 2.5 =$50,000

3- Target sales ($) = Total fixed costs + Target profit

Contribution margin ratio (%)
12,000 + 18,000 = 50,000 $
60%
 Margin of Safety
Margin of Safety = Actual or Budgeted Sales − Break-Even Sales (per unit or
dollars)
Margin of Safety % = Margin of Safety / sales
Changing Prices
What sales level will be needed at the new price to earn a target profit of
$10,500?
Contribution Margin Ratio Method :
Total Fixed Costs + Target Profit
= Target Sales $ 
Contribution Margin Ratio % 
12,000 + 10,500
= $30,000
75%
Unit Contribution Margin Method:
Total Fixed Costs + Target Profit
= TargetUnits (Q)
UnitContribution Margin
12,000 + 10,500
= 7,500 Units
$3.00

- Changing Variable Costs and Volume

Profit = (Unit Price × Q) − (Unit Variable Costs × Q) − Total Fixed Costs
- Changing Fixed Costs and Prices
Unit Contribution Margin Method
Total Fixed Costs  Target Profit
 Target Units (Q)
Unit Contribution Margin
$15,000  $16,800
 25,440 units
$1.25 Degree of Operating Leverage
Degree of operating leverage measures the extent to which fixed costs are
used to operate the business. In general, high fixed costs indicate that a
company is highly leveraged
Contribution Margin
Degree of Operating Leverage =
Net Operating Income

Weighted-Average Contribution Margin Ratio

Total Fixed Costs + Target Profit
= Target Sales $ 
Weighted-Average Unit Contribution Margin Ratio %

$12,000 + $15,000
= $43,200
62.5%

Coffee Sales Revenue = $43,200 × 71.43% = $30,858

 Process Costing
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Total Cost
Average Unit Cost =
Total Units Produced

Overhead cost

Estimated Total
Manufacturing Overhead Cost
Predetermined Overhead Rate =
Estimated Total Cost Driver

- The allocation base is a cost driver that causes overhead.

Overhead applied = OH Rate × Actual activity

OH Rate: Based on estimates, and determined before the period begins.

Actual activity: Actual amount of the allocation base, such as direct labor-
hours, incurred during the period.

Overapplied and Underapplied Overhead

Overapplied Manufacturing Overhead (credit balance)
Decreases Cost of Goods Sold
Underapplied Manufacturing Overhead (debit balance)
Increases Cost of Goods Sold