MANAGERIAL ACCOUNTING AND COST CONCEPTS SUMMARY OF COST CLASSIFICATIONS

PURPOSE OF COST CLASSIFICATION COST CLASSIFICATIONS

Assigning costs to cost objects Direct cost (can be easily traced)
Cost object - anything for which cost data desired - including products, customers, Indirect cost (cannot be easily traced)
jobs and organizational sub-units. Accounting for costs in manufacturing Manufacturing cost:
companies Direct materials
Direct labor
COST Manufacturing overhead
Non-manufacturing costs:
Selling costs
Administrative costs
DIRECT INDIRECT Preparing financial statements Product costs (inventoriable)
Period costs (expensed)
Direct cost - cost that can be easily and conveniently traced to a specified cost Predicting cost behavior in response to Variable cost (proportional to activity)
object changes in activity Fixed cost (constant in total)
Mixed cost (has variable and fixed
Indirect cost - cost that cannot be easily and conveniently traced to a specified elements)
cost object Making decisions Differential cost (differs between
alternatives)
Sunk cost (should be ignored)
*to be traced to a cost object such as a particular product, the cost must be caused Opportunity cost (forgone benefit)
by the cost object

Common cost - cost that is incurred to support a number of cost objects but
cannot be traced to them individually
*a type of indirect cost MANUFACTURING COSTS

1. Direct materials - materials that become an integral part of the finished product
and whose cost can be conveniently traced to the finished product
2. Direct labor / touch labor - costs that can be easily traced to individual units of
product
3. Manufacturing overhead - all manufacturing costs except direct materials and Public relations
direct labor Similar costs involved in the overall, general administration of the
*includes: organization as as a whole
Indirect materials
Indirect labor
Maintenance and repairs on production equipment COST CLASSIFICATIONS FOR PREPARING FINANCIAL STATEMENTS
Heat and light
Property taxes *matching principle is based on the accrual concept:
Depreciation “costs incurred to generate a particular revenue should be recognized as
Insurance on manufacturing facilities expenses in the same period that the revenue is recognized”
*only those costs associated with operating the factory are in included in
manufacturing overhead Product costs - all costs involved in acquiring or making a product
*various names used for manufacturing overhead Direct materials
Indirect manufacturing cost Direct labor
Factory overhead Manufacturing overhead
Factory burden *are recorded as expenses in the period in which the related products
are sold
NON-MANUFACTURING COSTS

1. Selling costs - all costs incurred to secure customer orders and get the finished Period costs - all the costs that are not product costs
product to the customer
- sometimes called order-getting and order-filling costs MANUFACTURING COSTS
Advertising
Shipping
Sales travel
Sales commissions
Sales salaries PRIME COST CONVERSION COST
Costs of finished goods warehouses
(DIRECT MATERIALS + DIRECT LABOR) (DIRECT LABOR + MANUFACTURING OVERHEAD COST)
2. Administrative costs - all costs associated with the general management of an
organization rather than with manufacturing or selling
Executive compensation
General accounting
Secretarial
COST CLASSIFICATIONS FOR PREDICTING COST BEHAVIOR *activity base/ cost driver - a measure of whatever causes the incurrence of a
variable cost
(E.G)
Direct-labor hours machine-hours units produced & units sold
Cost Behavior - refers how a cost reacts to changes in the level of activity
FIXED COSTS - cost that remains constant, in total, regardless of changes in the
level of activity
(ex) straight-line depreciation, insurance, property taxes, rent, supervisory
COST salaries, administrative salaries, and advertising
*fixed costs are not affected by changes in activity
*total fixed costs remain constant for large variations in the level of activity,
the average fixed costs per unit becomes progressively smaller as the level of
activity increases
VARIABLE COST FIXED COST
MIXED COST
FIXED COSTS

Cost structure - relative proportion of each type of cost in an organization

VARIABLE COST - varies, in total, in direct proportion to changes in the level of COMMITTED FIXED COSTS DISCRETIONARY FIXED COSTS
activity
Committed fixed costs - represent organizational investment with a multiyear
Cost of goods sold for a merchandising company planning horizon that can’t be significantly reduced even for short periods of time
Direct materials without making fundamental changes
Direct labor (ex) investments in facilities and equipment, as well as real estate taxes,
Variable elements of manufacturing overhead (indirect materials, insurance expenses, and salaries of top management
supplies, and power)
Variable elements of selling and administrative expenses (commissions
and shipping costs) Discretionary fixed costs (managed fixed costs) - arise from annual decisions by
management to spend on certain fixed costs items
- must be variable with respect to activity base (ex) advertising, research, public relations, management development
programs, and internships for students
 Relevant range - the range of activity within the assumption that cost behavior *variable portion represents the cost incurred for actual consumption of the
is strictly linear is reasonably valid service (it varies in proportion to the amount of service actually consumed)

METHODS IN ESTIMATING THE FIXED AND VARIABLE COMPONENTS OF A

MIXED COST:
1. Account analysis - an account is classified as either variable or fixed based on
the analyst’s prior knowledge of how the cost in the account behaves
2. Engineering approach -involves a detailed analysis of what cost behavior should
be, based on an industrial engineer’s evaluation of the production methods to be
used, the materials specifications, labor requirements, equipment usage,
production efficiency, power consumption, and so on.
3. High-low method
Both methods
4. Least-squares regression analysis
estimate the fixed and
variable elements of a
mixed cost by
analyzing past records
MIXED COSTS/SEMIVARIABLE COSTS - contains both variable and fixed cost
of cost and activity
elements
data

Y = a + bX Cost - known as the dependent variable because the amount of cost incurred
, during a period depends on the level of activity for the period
Y = The total mixed cost
a = The total fixed cost (the vertical intercept of the line) *(as the level of activity increases, total cost will also ordinarily increase)
b = The variable cost per unit of activity (the slope of the line)
X = The level of activity
Activity - known as the independent variable because it causes variations in the
cost

*the fixed portion of a mixed cost represents the minimum cost of having a *cost behavior is considered linear whenever a straight line is a reasonable
service ready and available for use approximation for the relation between cost and activity.
HIGH-LOW METHOD
 -based on the rise-over-run formula for the slope of a straight line
VC = SLOPE OF THE LINE = RISE/RUN =Y2 - Y1 / X2 - X1
VC = COST AT THE HIGH ACTIVITY LEVEL - COST AT THE LOW ACTIVITY LEVEL
HIGH ACTIVITY LEVEL - LOW ACTIVITY LEVEL
Gross margin . . . . . . . . . . . . . . . . . . xx
Selling and administrative expenses:
Selling . . . . . . . . . . . . . . . . . . . . xx
Administrative . . . . . . . . . . . . . xx (xx)
Net operating income . . . . . …... . … xx

Contribution Format
VC = CHANGE IN COST Sales . . . . . . . . . . . . . . . . . . ……………... .xx
CHANGE IN ACTIVITY Variable expenses:
Cost of goods sold . . . . . . . xx
Variable selling . . . . . . . . . . xx
FIXED COST ELEMENT = TOTAL COST - VARIABLE COST ELEMENT Variable administrative . . . xx (xx)

Contribution margin . . . . . ………. . . . ….xx

Fixed expenses:
LEAST-SQUARES REGRESSION METHOD - use all of the data to separate a mixed Fixed selling . . . . . . . . . . . . xx
cost into its fixed and variable components Fixed administrative . . . . . xx (xx)
Net operating income . . . . . . . xx
Regression line - of the form Y = a + bX
a= total fixed cost
b= variable cost per unit of activity
COST OF GOODS SOLD (COGS) = BEG. MERCH. INV + PURCHASES - END. MERCH INV

Traditional Format COST CLASSIFICATIONS FOR DECISION MAKING

Sales . . . . . . . . . . . . . . . . . . . . . . . . . xx
Cost of goods sold * . . . . . . . . . . . .(xx)
It is essential in making decisions to have a grasp of the concepts (differential cost,
opportunity cost, and sunk cost)