Managerial Accounting and Cost

Concepts
Chapter 02

PowerPoint 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
 2-2

COST CLASSIFICATIONS
1. Cost Classifications for Assigning Costs to
Cost Objects
* Direct Cost
* Indirect Cost
2. Cost Classifications for Manufacturing
Companies
* Manufacturing Costs
- Direct Materials
- Direct Labor
- Manufacturing Overhead
* Nonmanufacturing Costs
- Selling Cost
- Administrative Cost
 2-3

COST CLASSIFICATIONS
3. Cost Classifications for Preparing Financial
Statements
* Product Costs
* Period Costs
4. Cost Classifications for Predicting Cost Behavior
* Variable Cost
* Fixed Cost
* Mixed Costs
5. Cost Classifications for Decision Making
* Differential Cost and Revenue
* Opportunity Cost
* Sunk Cost
 2-4

Cost Classifications for Assigning

Costs to Cost Objects
A cost object is anything for which cost data
are desired—including products,
customers, jobs, and organizational
subunits
• Direct Cost
A direct cost is a cost that can be easily and conveniently
traced to a specified cost Object
• Indirect Cost
An indirect cost is a cost that cannot be easily and
conveniently traced to a specified cost object
 2-5

Cost Classifications for Manufacturing

Companies
Manufacturing Costs

Direct Direct Manufactu

Materials Labor ring
Overhead

The Product
 2-6

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

 2-7

Direct Labor

Those labor costs that can be easily

traced to individual units of product.

Example: Wages paid to automobile assembly workers

 2-8

Manufacturing Overhead
Manufacturing costs that cannot be easily
traced directly to specific units produced.

Examples: Indirect materials and indirect labor

 2-9

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

Prime Conversion
Cost Cost
 2-10

Nonmanufacturing Costs

Administrative
Costs

All executive,
organizational, and
clerical costs.
 2-11

Cost Classifications for Preparing Financial

Statements
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
 2-12

Cost Classifications for Predicting Cost

Behavior

Variable Cost
Your total texting bill is based on how many texts
you send.
Total Texting Bill

Number of Texts Sent

 2-13

Variable Cost Per Unit

The cost per text sent is constant at

5 cents per text message.

Cost Per Text Sent

Number of Texts Sent

 2-14

The Activity Base (Cost Driver)

Units Machine
produced hours

A measure of what
causes the
incurrence of a
variable cost

Miles Labor
driven hours
 2-15

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.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

Within Monthly Plan
 2-16

Fixed Cost Per Unit

Within the monthly contract allotment, the average
fixed cost per cell phone call made decreases as
more calls are made.

Monthly Cell Phone

Contract Fee

Number of Minutes Used

Within Monthly Plan
 2-17

Types of Fixed Costs

Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced in short-term by current
the short term. managerial decisions

Examples Examples
Depreciation on Buildings Advertising and
and Equipment and Real Research and
Estate Taxes Development
 2-18

The Linearity Assumption and the Relevant

Range
Economist’s A straight line
closely
Curvilinear Cost approximates a
Function curvilinear
variable cost line
Relevant within the
relevant range.
Total Cost

Range
Accountant’s Straight-Line
Approximation (constant
unit variable cost)

Activity
 2-19

Fixed Costs and the Relevant Range

90
Rent Cost in Thousands

The relevant range

Relevant of activity for a fixed
of Dollars

60 Range cost is the range of

activity over which
the graph of the
cost is flat.
30

0
0 1,000 2,000 3,000
Rented Area (Square Feet)
 2-20

Mixed Costs

Y
Total Utility Cost

o s t
d c
i x e
a l m
o t
T Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
 2-21

The Scattergraph Method

Use one data point to estimate the total level of activity
and the total cost.
Y Total maintenance cost = $11,000
20
Maintenance Cost

* ** *
1,000’s of Dollars

* *
**
10 * *
Intercept = Fixed cost: $10,000

0 X
0 1 2 3 4
Patient-days in 1,000’s
Patient days = 800
5-2
 2-22

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

5-2
 2-23

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
5-2
 2-24

The High-Low Method – An Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
5-2
 2-25

Least-Squares Regression Method

A method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between the X and Y variables.

This method uses all of the

data points to estimate
the fixed and variable
cost components of a
mixed cost.
The goal of this method is
to fit a straight line to the
data that minimizes the
sum of the squared errors.

5-2
 2-26

Least-Squares Regression Method

• Software can be used to
fit a regression line
through the data points.
• The cost analysis
objective is the same: Y
= a + bX
Least-squares regression also provides a statistic, called
the R2, which is a measure of the goodness
of fit of the regression line to the data points.

5-2
 2-27

Cost Classifications for Decision Making

• Differential Cost and Revenue
A difference in costs between any two alternatives is known
as a differential cost . A difference in revenues (usually just
sales) between any two alternatives is known as differential
revenue
• Opportunity Cost
The potential benefit that is given up when one alternative is
selected over another.
• Sunk Cost
Cost that has already been incurred and that cannot be
changed by any decision made now or in the future
 2-28

End of Chapter 02