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BASIC MANAGERIAL
ACCOUNTING CONCEPTS
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THE MEANING AND USES
OF COST
Determine the cost of products, services, customers, and other items to
managers.
Cost is the amount of cash or cash equivalent sacrificed for goods and/or
services that bring a current or future benefit to the organization.
As costs are used up in the production of revenues do expire.
Expired costs are called expenses.
The revenue per unit is called price.
Managerial accounting systems are structured to measure and assign
costs.
A cost object is any item such as a product, customer, department,
project, geographic region, plant, and so on, for which costs are
measured and assigned.
LO-1
COST CLASSIFICATION
Relationship to
item measured:
Cost Behavior: Direct & Indirect Decision Analysis:
Fixed, Variable Relevant, Sunk &
& Mixed Opportunity
Recognition
Manufacturing:
timing: Product
- Direct labor COST & Period Cost
- Direct
Material
- Fact.
Overhead Functional areas:
Output: - Administrative
- Product
- R&D
- Services Input: - Marketing, etc
Prime & Conversion
Source: Oliver, 2000 (Modified)
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DETERMINING PRODUCT
COST
Product (manufacturing) costs are costs, both direct and indirect, of
producing a product in a manufacturing firm or of acquiring a product in a
merchandising firm and preparing it for sale.
Only costs in the production of the value chain are included in product costs.
Direct materials are materials Direct labor is the labor that can be directly
that are a part of the final product traced to the goods being produced.
and can be directly traced to the Physical observation can be used to measure
goods being produced. the amount of labor used to produce a
The materials cost can be directly product.
charged to products because Those employees who convert direct
physical observation can be used materials into a product are classified as
to measure the quantity used by direct labor.
each product.
A company also have indirect labor costs.
Materials that become part of a Indirect labor is included in overhead and,
product usually are classified as therefore, is an indirect cost rather than a
direct materials. direct cost. LO-2
MANUFACTURING
OVERHEAD
All product costs Costs are included as manufacturing
other than direct overhead if they cannot be traced to
materials and direct the cost object of interest (e.g., unit of
labor are considered product).
manufacturing
Manufacturing overhead cost
overhead.
category includes a variety of items.
Manufacturing
Examples include depreciation on
overhead also is
plant buildings and equipment,
known as factory
janitorial and maintenance labor,
burden or indirect
plant supervision, materials
manufacturing
handling, power for plant utilities,
costs.
and plant property taxes.
LO-2
PRIME AND CONVERSION
COSTS
Product costs of DM, DL, and manufacturing overhead
can be grouped into prime cost and conversion cost:
Prime cost is the sum of direct materials cost and
direct labor cost.
Prime cost = Direct materials + Direct labor
Order- EXAMPLES
Sales personnel
getting Salaries &
Commissions
Advertising
EXAMPLES
Warehousing
Shipping
Customer Order-
Service
Filling
LO-2
ADMINISTRATIVE COSTS
Administrative costs include research, development, and
general administration of the organization and cannot be
assigned to either selling or production.
General administration ensures that the various activities
of the organization are integrated so that the overall
mission of the firm is realized.
Examples of general administrative costs are: Executive
salaries, legal fees, printing the annual report, and
general accounting.
Research and development costs include: Designing and
developing new products and must be expensed in the
period incurred. LO-2
p.48
PREPARING INCOME STATEMENTS:
COST OF GOODS MANUFACTURED
The cost of goods manufactured represents the total product cost of
goods completed during the current period and transferred to
finished goods inventory.
The cost of direct materials can be derived using formula:
The direct materials used is then used to calculate the cost of goods
manufactured as follows: + Direct materials
+ Direct labor
+ Manufacturing overhead costs
+ Beginning WIP inventory
- Ending WIP inventory
= Cost of goods manufactured LO-3
COST OF GOODS SOLD
LO-1
RELEVANT RANGE AND COST
RELATIONSHIPS
Relevant range is the range of output over which the assumed cost
relationship is valid for the normal operations of a firm.
Limits the cost relationship to the range of operations that the firm
normally expects to occur.
The following graph shows the relevant range which allows
managers to assume a linear cost relationship.
LO-1
FIXED COSTS
LO-1
DISCRETIONARY FIXED COSTS
AND COMMITTED FIXED COSTS
LO-1
VARIABLE COSTS
LO-1
THE REASONABLENESS OF
STRAIGHT-LINE COST
RELATIONSHIPS
Caution when applying cost behavior assumptions to output levels that fall
outside of the company’s relevant range of operations.
Straight-line cost relationships that are assumed within the relevant range may
actually be semi-variable costs.
Example: At extremely low levels of output, workers often use more materials
per unit or require more time per unit than they do at higher levels of output.
As the level of output increases, workers learn how to use materials and time
more efficiently so that the variable cost per unit decreases as more and more
output is produced.
LO-1
MIXED COSTS
Mixed costs are costs that have both a fixed and a variable
component.
Example: Overhead for a company may consist of a fixed supervisor
salary plus the cost of supplies that vary with the quantity of output
produced.
The formula and graph depiction for a mixed cost is as follows:
Total cost = Total fixed cost + Total variable cost
LO-2
STEP COSTS: NARROW/WIDE
STEPS
Some cost functions may be Step cost with wide steps are more
discontinuous. characteristic of fixed costs.
Known as step costs (or semi-fixed). Example: A company may have to
Displays a constant level of cost for a range lease production machinery.
of output and then jumps to a higher level If the machine can only produce
(or step) of cost at some point, where it 1,000 units and the company grows,
remains for a similar range of output. they will have to lease additional
machines for each 1,000 units of
If a step cost has narrow steps, it means production needed
that the cost changes in response to small
changes in output and we can approximate Resulting in the wide steps shown in
it as a variable cost (i.e., the red line). the following graph.
LO-2
METHODS FOR SEPARATING
MIXED COSTS INTO FIXED AND
VARIABLE COMPONENTS
Three methods of separating a mixed cost:
1. the high-low method
2. the scattergraph method
3. the method of least squares
Each method requires the assumption of a linear cost relationship.
LO-3
METHODS FOR SEPARATING
MIXED COSTS INTO FIXED AND
VARIABLE COMPONENTS
Expression of cost as an The independent variable measures
equation for a straight line is: output and explains changes in the
Total cost = Fixed cost + cost or other dependent variable.
(Variable rate x Output) A good independent variable is one
that causes or is closely associated
The dependent variable is a with the dependent variable.
variable whose value Many managers refer to an
depends on the value of independent variable as a cost
another variable. driver.
a. wide span of production where total fixed costs are expected to remain
the same
b. wide range of sales where total variable costs remain the same
c. wide range of sales where all costs remain the same
d. narrow range of production where total variable costs remain the same
ABC Company has $50,000 in fixed cost per month. In April, 50,000 units
were produced. In May, 55,000 units were produced.
Which of the following statements is true?
The following information was available about supplies cost for the first three months
of the year: Using the high-low method, an estimate of supplies cost at 20,000 units
of production would be
Month Production Volume Supplies Cost
January 12,000 $ 80,000
February 23,000 140,000
March 27,000 164,000
a. $96,000
b. $112,000
c. $124,800
d. $130,400