C HAPTER # 02

(MANAGERIAL ACCOUNTING AND COST CONCEPTS)

N OTES

Managerial Accounting

 Comparison of financial and managerial accounting.

Focuses Financial Accounting Managerial Accounting
Definition The process of recording, summarizing, The process of identifying, measuring,
and analyzing and entity's financial interpreting, and communicating
transactions and reporting them in information to management to assist
financial statements to its existing and them in planning, decision making,
potential investors, lenders, and creditors. and risk management.
Requirements Mandatory Optional
Primary audience Both (external + internal) Internal employees or managers only
Regulations GAAP None
Frequency Quarterly, annually, or per-period As needed & ongoing
External review Auditors & regulators None
Emphasis on Past transactions Information to aid decisions for the
future.
Scope Company wide Narrow per segment, product, etc. as
needed.
Relevance of data 100% accurate & to the point. For verifying, might not be accurate.
Information Available for public on the company’s Secret
website or stakeholders.
Segmentation None Every department is needed to create
their own report.

 Types of business.
1. Services.
The type of product that is intangible and do not exist physically.
Services make up the large business factor like law firms, hospitals, and banks etc.
Services interact with a daily basis activity.
Service companies do not have the cost of goods sold because there is no product being sold.

2. Trading.
Trading companies are those which sell products but do not make their own products that might be
broken up into wholesaler (buy product from manufacturer and sell them to other companies or
retailers.) and retailer (sell product directly to the end user or customer.) This kind of business also
known as also known as merchandising.

3. Manufacturing.
Manufacturing companies by a raw material, create their own product and then sell the manufactured
product.
For intense, Dell computers is a well-known manufacturing company that buys processors as raw
material and create their own computers, laptop, and notebooks. They sell their product directly to
consumer and retailers.
These companies use labor and machinery to turn raw material into a product.
All manufacturing companies have three different inventory accounts;
o Raw material inventory,
o Work in progress,
o Finished goods inventory.

Cost is the amount of price that is paid to acquire an

asset and can't be expired.

Expense is the (daily basis) amount of rice that refers

to the consumption of the item acquired and the
expired money is called an expense.

 Cost is classified into two main types;

1. Manufacturing cost.
The cost that is used or consumed in a business during the manufacturing trial that is
called manufacturing cost.
Manufacturing cost consists of three main aspects that are;

o Raw material => all the materials used in the product like wood, plastic is called raw
materials the material that go in final product are called raw material this term is somewhat
misleading because it seems to imply and proceed natural resources like wood, plastic or
iron. Raw material may include both direct and indirect materials.
- Direct materials are those that become an integral part of the finished product and
whose cost can be conveniently traced to the finished product. For example, the quality
of plastic used to make a toy aircraft is a direct material.
- Material such as glue that can't be seen bus included as the part of manufacturing
overhead is called indirect material.

o Direct labor => that we can easily and conveniently identify in the product call direct labor
it is sometimes called touch play Because direct labor workers typically touch the product
while its being made for example the paint on the toy aircraft and its shape can be seen as
direct labor.
- All the labor that we can't easily identify is called indirect labor. Just like indirect
material, indirect labor is treated as a part of manufacturing overhead.

o Manufacturing overhead => it consists of indirect labor, indirect material, and electricity
bill.

2. Non-Manufacturing cost.
It is classified into two main categories that are;
 i). Administrative cost => all costs associated with the general management of an
organization rather than with a manufacturing or selling. For example, the cost includes executive
compensation, general accounting, Public Relations etc.

ii). Selling cost => all the costs that are incurred to secure customer Orders and get the
finished product to the customer. These costs are sometimes called order- getting cost & order- filling
cost. For intense, the cost include advertising, shipping, sales travel, sales Commission, sales
salaries etc.

The matching principle is based on the accrual
concept that cost incurred to generate a
particular revenue should be recognized as
expense in the same period. The revenue is
recognized. This means, if a cost is incurred to
acquire or make something that will eventually
be sold, then the cost should be recognized as
the expense only when the sale takes place,
that is when the benefit occurs.
Non-manufacturing called is also known as period
cost.
While manufacturing cost is also known as product
cost.
In the case of manufacturing goods, product costs
consist of direct material, direct labor, and
manufacturing overhead. Product cost is also called
inventoriable cost.

Prime cost;

(direct material + direct labor),

Conversion cost;

(direct labor + manufacturing

overhead).

 Cost behavior;
It refers to how a cost reacts to change in the level of activity. As the activity level Rises or
falls, a particular caused may rise and fall as well, or it may remain constant.

Predicting cost behavior in response to changes in activity has two main aspects that are;

1. Variable cost (proportional to activity).

It is the cost that changes, in total, indirect proportion to changes in the level of activity. A
good example of variable cost is direct material.

2. Fixed cost (constant in total).

It is the cost that remains constant, in total, regardless of changes in the level of activity.
Unlike variable cost, fixed costs are not affected by changes in activity. Rent is a good
 example of fixed cost. When we say the cost is fixed, it means it is fixed within some
relevant range.

- Relevant range is the range of activity within which the assumptions about
variable and fixed cost are valid. For intense, the assumption that the rent for
Diagnostic machine is $8,000 per month is valid within the relevant range of 0 to
2,000 tests per month.

 Cost classifications.
i. Direct cost.

It is the cost that can be easily and conveniently traced to a specific cost object the concept of
direct cost extends beyond direct material and direct labor.

ii. Indirect cost

It is the cost that cannot be easily and conveniently traced to specified cost object.

 Cost classification for decision making.

1) Differential cost and revenue.

A difference in cost between any two alternatives is called differential cost also known as
incremental cost that refer only to an increase in cost from one alternative to another. While
decrease in cost should be referred to as discriminant cost.

A difference in revenues between any two alternatives is called differential revenue.

2) Opportunity cost.

It is the potential benefit that is given up when one alternative is selected over another.

3) Sunk cost.

Is a cost that has already been incurred and that cannot be changed by any decisions made
now or in future. Because some cost cannot be changed by any decision.

Cost increase => Incremental cost

Cost decrease => Decrement cost

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(Prepared by; Ayesha Raees)