Chapter 1

Managerial Accounting and Cost Concepts

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
1-2

Planning and Control Cycle

Formulating
Formulatinglong-
long- Begin
and
andshort-term
short-termplans
plans
(Planning)
(Planning)

Comparing
Comparingactual
actual Implementing
Implementing
to
toplanned
planned Decision plans
performance Making plans(Directing
(Directing
performance and
(Controlling) andMotivating)
Motivating)
(Controlling)

Measuring
Measuring
performance
performance
(Controlling)
(Controlling)
1-3

Comparison of Financial and Managerial

Accounting
1-4

Manufacturing Costs
Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product
1-5

Direct Materials
Raw materials that become an integral part of
the product and that can be conveniently traced
directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile
1-6

Direct Labor

Those labor costs that can be easily

traced to individual units of
product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers
1-7

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

Examples:
Examples: Indirect
Indirect materials
materials and
and indirect
indirect labor
labor

Materials used to support Wages paid to employees

the production process.
Examples: Lubricants and
cleaning supplies used in the
automobile assembly plant.
who are not directly
involved in production
work.
Examples: Maintenance
workers, janitors and
security guards.
1-8

Classifications of
Nonmanufacturing Costs

Administrative
Selling Costs
Costs

Costs necessary to get All executive,

the order and deliver organizational, and
the product. clerical costs.
1-9

Product Costs Versus Period Costs

Product costs include Period costs are not
direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Cost of
Inventory Goods Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
1-10

Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company? (There may be
more than one correct answer.)
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
1-11

Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company? (There may be
more than one correct answer.)
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
1-12

Prime Cost and Conversion Cost

Manufacturing costs are often
classified as follows:

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Material
Material Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost
1-13

Comparing Merchandising and

Manufacturing Activities
Merchandisers . . . Manufacturers . . .
▫ Purchase finished ▫ Purchases raw
goods from suppliers materials from
for resale to suppliers.
customers. ▫ Produce and sell
finished goods to
customers.
1-14

Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
 Cash  Cash
 Receivables  Receivables
 Prepaid Expenses  Prepaid Expenses
 Merchandise Inventory  Inventories:
1. Raw Materials
2. Work in Process
3. Finished Goods
1-15

Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
 Cash  Cash
 Receivables  Receivables
Materials waiting to
 Prepaid Expenses  Prepaid Expenses
be processed.
 Merchandise Inventory
Partially complete  Inventories:
products – some 1. Raw Materials
material, labor, or 2. Work in Process
overhead has been
3. Finished Goods
added.
Completed products
awaiting sale.
1-16

The Income Statement

Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for
merchandisers.
Merchandising Company
Cost of goods sold:
Beg. merchandise
inventory $ 14,200
+ Purchases 234,150
Goods available
for sale $ 248,350
- Ending
merchandise
inventory (12,100)
= Cost of goods
sold $ 236,250
1-17

Inventory Flows

Withdrawals
Withdrawals
Beginning
Beginning Additions
Additions Ending
Ending
balance
balance
+ to
to inventory
inventory
= balance
balance
+ from
from
inventory
inventory
1-18

Quick Check 
If your inventory balance at the beginning of
the month was $1,000, you bought $100
during the month, and sold $300 during the
month, what would be the balance at the end
of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.
1-19

Quick Check 
If your inventory balance at the beginning of
the month was $1,000, you bought $100
during the month, and sold $300 during the
month, what would be the balance at the end
of the month?
A. $1,000. $1,000 + $100 = $1,100
B. $ 800. $1,100 - $300 = $800
C. $1,200.
D. $ 200.
1-20

Schedule of Cost of Goods

Manufactured
Calculates the cost of raw
materials, direct labor and
manufacturing overhead used
in production.

Calculates the manufacturing

costs associated with goods
that were finished during the
period.
1-21

Schedule of Cost of Goods

Manufactured
Manufacturing Work
As items
AsCosts are removed
items are removed from
from
Raw Materials In Process
raw
raw materials
materials inventory
inventory and
and
Beginning raw
materials inventory placed
placed into
into the
the production
production
+ Raw materials process,
process, they
they are
are called
called direct
direct
purchased
= Raw materials materials.
materials.
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
1-22

Schedule of Cost of Goods

Manufactured
Manufacturing Work
Conversion
Conversion
Raw Materials Costs In Process
costs
costsare
arecosts
costs
Beginning raw Direct materials incurred
incurredtoto
materials inventory + Direct labor convert
+ Raw materials + Mfg. overhead convert the
the
purchased = Total manufacturing direct
directmaterials
materials
= Raw materials costs into
intoaafinished
finished
available for use product.
product.
in production
– Ending raw materials
inventory
= Raw materials used As
Asitems
itemsare
areremoved
removedfrom
from raw
raw
in production materials
materialsinventory
inventoryand
andplaced
placedinto
into
the
the production
production process,
process, they
theyare
are
called
calleddirect
direct materials.
materials.
1-23

Schedule of Cost of Goods

Manufactured
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory All
All manufacturingcosts
manufacturing costs incurred
incurred
process inventory
= Raw materials used during
duringthe
theperiod
periodare
=are added
Costadded to
of goods tothe
the
in production beginning balance of work in
manufactured.
beginning balance of work in
process.
process.
1-24

Schedule of Cost of Goods

Manufactured
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory process inventory
Costs
Costs associated
associated with
withthe
the goods
goods thatthat
= Raw materials used = Cost of goods
are completed
arein production during
completed duringthe
theperiod
periodare are manufactured.
transferred
transferredto
tofinished
finished goods
goods
inventory.
inventory.
1-25

Cost of Goods Sold

1-26

Manufacturing Cost Flows

Balance Sheet Income
Costs Inventories Statement
Material Purchases Raw Materials Expenses

Direct Labor Work in

Process
Manufacturing
Overhead Finished Cost of
Goods Goods
Sold

Selling and Period Costs Selling and

Administrative Administrative
1-27

Quick Check 
Beginning raw materials inventory was
$32,000. During the month, $276,000 of raw
material was purchased. A count at the end of
the month revealed that $28,000 of raw
material was still present. What is the cost of
direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000
1-28

Quick Check 
Beginning raw materials inventory was
$32,000. During the month, $276,000 of raw
material was purchased. A count at the end of
the month revealed that $28,000 of raw
material was still present. What is the cost of
direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000
1-29

Quick Check 
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.
1-30

Quick Check 
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.
1-31

Quick Check 
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
1-32

Quick Check 
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
1-33

Quick Check 
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for
the month was $760,000. The ending finished
goods inventory was $150,000. What was the
cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
1-34

Quick Check 
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for
the month was $760,000. The ending finished
goods inventory was $150,000. What was the
cost of goods sold for the month?
A. $ 20,000.
B. $740,000. $130,000 + $760,000 = $890,000
$890,000 - $150,000 = $740,000
C. $780,000.
D. $760,000.
1-35

Cost Classifications for Predicting

Cost Behavior

How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
business
business activity.
activity.

 Total
Total variable
variable costs
costs change
change
when
when activity
activity changes.
changes.

 Total
Total fixed
fixed costs
costs remain
remain
unchanged
unchanged when when activity
activity
changes.
changes.
1-36

Variable Cost
Your total electricity bill is based on
how many units you consumed.
Total Electricity Bill

Number of Units Used

1-37

Variable Cost Per Unit

Per unit charges are constant.

Per Unit Charges

Number of units
consumed
1-38

Fixed Cost
Your electricity meter charges are fixed for the month.
These charges do not change based on the number of
units consumed.
Monthly Meter
Charges

Number of Units Consumed

1-39

Fixed Cost Per Unit

Within the month, the average fixed cost per unit will
decreases as more units are consumed
Monthly Meter Charges

Number of Units Consumed

1-40

Cost Classifications for Predicting

Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
1-41

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.
1-42

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.
1-43

Assigning Costs to Cost Objects

Direct costs Indirect costs
• Costs that can be • Costs that cannot be
easily and conveniently easily and conveniently
traced to a unit of traced to a unit of
product or other cost product or other cost
object. object.
• Examples: Direct • Example: Manufacturing
material and direct labor overhead
1-44

Cost Classifications for Decision

Making
Every decision involves a choice
between at least two alternatives.

Only those costs and benefits that differ

between alternatives are relevant to the
decision. All other costs and benefits can
and should be ignored.
1-45

Differential Costs and Revenues

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

Net Differential Benefit is:

$200
1-46

Opportunity Costs
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.
1-47

Sunk Costs
Cannot be changed by any decision. They
are not differential costs and should be
ignored when making decisions.

Example: You bought an automobile that cost

$10,000 two years ago. The $10,000 cost is
sunk because whether you drive it, park it, trade
it, or sell it, you cannot change the $10,000 cost.
1-48

Quick Check 
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
meeting. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not
relevant.
1-49

Quick Check 
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not
relevant.
1-50

Quick Check 
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either,
but you don’t want to waste money
needlessly. Is the annual cost of licensing your
car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
1-51

Quick Check 
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either,
but you don’t want to waste money
needlessly. Is the annual cost of licensing your
car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
1-52

Quick Check 
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
1-53

Quick Check 
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
1-54

Summary of the Types of Cost

Classifications
Predicting
Financial
Cost
Reporting
Behavior

Assigning
Decision
Costs to Cost
Making
Objects
1-55

End of Chapter 1