Managerial Cost Concepts, Analysis

and Behavior
 Group 2 Presentation Overview

• Cost terms, concepts and classifications for predicting cost behaviour

and for decision making

• Comparison between merchandising and manufacturing activities and

their respective financial statements

• Cost analysis and behaviour patterns including its measurement

• Contribution margin income statement

Cost terms, Concepts and
Classifications for Predicting cost
behavior and for Decision making
VARGAS, DANN CHRISTOPHER V.
 What is Cost?

It is a payment of cash or the commitment to pay cash in the future for the
purpose of generating revenues.
Cost object

A cost object may be a product, a sales territory, a

department, or an activity, such as research and
development.

Costs identified with cost objects are either Direct costs or

Indirect costs.
 According to Ease of Traceability
-Direct Cost
-Indirect Cost
Direct costs

Are identified with and can be traced to a cost object.

Indirect Cost

It cannot be identified with or traced to a cost object.

 According to Management Functions:
-Manufacturing Cost
-Non Manufacturing Cost
Manufacturing Costs

• The cost of a manufactured product includes the cost of

materials used in making the product.
• In addition, the cost of a manufactured product includes
the cost of converting the materials into a finished
product.
Direct Material Cost

Manufactured products begin with raw materials that are converted

into finished products. The cost of any material that is an integral
part of the finished product is classified as a direct materials cost.

• For example, auto manufacturers such as General Motors, Ford,

and Toyota use steel, plastic, and tires as raw materials in making
cars. Raw materials that can be physically and directly associated
with the finished product during the manufacturing process are
direct materials.
 To be classified as a direct materials cost,
the cost must be both of the following:

 An integral part of the finished product

 A significant portion of the total cost of the product.
Direct Labor Cost

Most manufacturing processes use employees to convert materials

into finished products. The cost of employee wages that is an
integral part of the finished product is classified as direct labor cost.

Like a direct materials cost, a direct labor cost must meet both of
the following criteria:
An integral part of the finished product
A significant portion of the total cost of the product
Manufacturing Overhead

Manufacturing overhead consists of costs that are indirectly

associated with the manufacture of the finished product.

These costs may also be manufacturing costs that cannot be

classified as direct materials or direct labor.
 Manufacturing overhead consists of the following:

 Indirect material costs. The cost of materials necessary to manufacture a product

that are not easily traced to the product or not worth tracing to the product.

 Indirect labor costs. The cost of workers who are involved in the production process
but whose time cannot easily be traced to the product. For example, supervisors in the
production process who oversee several different products and are responsible for
hiring employees, scheduling employees, and ordering materials are considered
indirect labor.

 Other manufacturing costs. These are all other costs for items associated with the
factory, including equipment maintenance, insurance, utilities, and depreciation.
NON -MANUFACTURING COST

Costs that are not related to the production of goods are called
nonmanufacturing costs; they are also referred to as period costs.

These costs have two components—selling costs and general and

administrative costs—which are
 According to Timing of Charge
against Revenue:

- Products Cost (Manufacturing Cost)

- Period Cost (Non Manufacturing Cost)
 Product Costs and Period Costs

For financial reporting purposes, costs are classified as product costs or period costs.  

 Product costs consist of manufacturing costs: direct materials, direct labor, and
factory overhead.

Period costs consist of selling and administrative expenses. Selling expenses are
incurred in marketing the product and delivering the product to customers.
Administrative
 Presentation of Manufacturing and
Non-Manufacturing Costs in Financial Statements
Why is it important to make this distinction?

 Distinguishing between the two categories is critical because the category

determines where a cost will appear in the financial statements. All manufacturing
costs (direct materials, direct labor, and manufacturing overhead) are attached to
inventory as an asset on the balance sheet until the goods are sold, at which point the
costs are transferred to cost of goods sold on the income statement as an expense.
 As we indicated earlier, nonmanufacturing costs are also called period costs; that is
because they are expensed on the income statement in the time period in which they
are incurred.
Classifications for Predicting Cost
behavior and for Decision making
 
 According to Relevance to Decision Making

Relevant cost - cost that will differ under alternative courses of action. In other
words, these costs refer to those that will affect a decision.
Standard cost - predetermined cost based on some reasonable basis such as
past experiences, budgeted amounts, industry standards, etc. The actual costs
incurred are compared to standard costs.
 According to Relevance to Decision Making

Opportunity cost - benefit forgone or given up when an alternative is chosen over the other/s.

Example: If a business chooses to use its building for production rather than rent it out to tenants, the

opportunity cost would be the rent income that would be earned had the business chose to rent out.

Sunk costs - historical costs that will not make any difference in making a decision. Unlike relevant

costs, they do not have an impact on the matter at hand.

Controllable costs - refer to costs that can be influenced or controlled by the manager. Segment

managers should be evaluated based on costs that they can control.

COMPARISON OF MANUFACTURING
AND MERCHANDISING ACTIVITIES
AND ITS RESPECTIVE FINANCIAL
STATEMENTS
ABIOG, ALONA B.
COMPARISON OF MANUFACTURING AND
MERCHANDISING ACTIVITIES
HOW MANUFACTURING COSTS FLOW THRU
ACCOUNTS
THREE TYPES OF INVENTORY IN
MANUFACTURING COMPANIES
 BALANCE SHEET PRESENTATION OF
MANUFACTURING AND MERCHANDISING COMPANIES
COST OF GOODS SOLD COMPONENTS
 INCOME STATEMENT PRESENTATION OF
MERCHANDISING AND MANUFACTURING COMPANIES
 COST OF GOODS MANUFACTURED

• Cost of Goods Manufactured is the total cost of making products

that are available for sale during the period.
• The statement of cost of goods manufactured is prepared using
the following three steps:
1. Determine the cost of materials used.
2. Determine the total manufacturing costs incurred.
3. Determine the cost of goods manufactured.
 MANUFACTURING COMPANY –
INCOME STATEMENT WITH
STATEMENT OF COST OF GOODS
MANUFACTURED
 COST ANALYSIS &
BEHAVIOR PATTERNS
CATIBOG, NICEL JOY D.
COST ANALYSIS & BEHAVIOR PATTERNS
COST ANALYSIS

Cost analysis is a systematic process for calculating

and comparing benefits and costs of a project.

Purpose of Cost Analysis:

 To determine if it is a sound investment/decision.

To provide a basis for comparing projects.

COST BEHAVIOR

 It is the manner in which a cost changes as a related business

activity changes.
The behavior of costs is useful to managers for a variety of reasons.
A prerequisite to understanding cost-volume-profit (CVP)
relationships is knowledge of how costs behave.
Knowing how costs behave is also useful for estimating costs, which
affects a variety of decisions such as whether to replace a machine.
Understanding the behavior of a cost depends on the
following:
 Identifying the activities that cause the cost to change.
These activities are called activity bases (or activity
drivers).

 Specifying the range of activity over which the changes

in the cost are of interest. This range of activity is called
the relevant range.
COST BEHAVIOR ANALYSIS

 It is the study of how specific costs respond to changes in the

level of business activity.
 A knowledge of cost behavior helps management plan operations
and decide between alternative courses of action.
The starting point in cost behavior analysis is measuring the key
business activities.
The activity index identifies the activity that causes changes in
the behavior of costs.
TYPES OF COST BY BEHAVIOR

1. VARIABLE COSTS

2. FIXED COSTS

3. MIXED COSTS
VARIABLE COSTS

Variable costs are costs that vary in total directly or in

direct proportion with changes in the activity level.
If the level increases 10%, total variable costs will
increase 10%. If the level of activity decreases by 25%,
variable costs will decrease 25%.

Examples:
Raw materials and direct labor for a manufacturer; cost of
goods sold, sales commissions, and shipping costs; and
gasoline in airline and trucking companies.
TOTAL VARIABLE COST
VARIABLE COST PER UNIT

The cost per show is constant.

 Assume direct materials, direct labor, and all other variable
production costs amount to $60 per unit.
Table 1.1 "Variable Cost Behavior for Bikes Unlimited" provides the total
and per unit variable costs at three different levels of production, and
Figure 1.1 "Total Variable Production Costs for Bikes Unlimited" graphs
the relation of total variable costs (y-axis) to units produced (x-axis).

Note that the slope of the line represents the variable cost per unit of
$60 (slope = change in variable cost ÷ change in units produced).
Table 1.1 Variable Cost Behavior for Bikes Unlimited
Figure 1.1 Total Variable Production Costs for Bikes Unlimited
Using Different Activities to Measure Variable
Costs

Question: At Bikes Unlimited, it is reasonable to assume that

the activity, number of units produced, will affect total
variable costs for direct materials and direct labor. However,
companies often use a different activity to estimate total
variable costs. What types of activities might be used to
estimate variable costs?
 Answer: The type of activity used to estimate variable costs depends on the cost.

1. A law firm might use the number of labor hours to estimate labor costs.

2. An airline such as American Airlines might use hours of flying time to estimate
fuel costs.

3. A mail delivery service such as UPS might use the number of packages processed
to estimate labor costs associated with sorting packages.

4. A retail store such as Best Buy might use sales dollars to estimate cost of goods
sold.
 Variable costs are affected by different activities
depending on the organization. The goal is to find the
activity that causes the variable cost so that accurate
cost estimates can be made.
FIXED COSTS

Fixed costs are costs that remain the same in total regardless of
changes in the activity level.
Total fixed costs remain constant as activity changes, it follows
that fixed costs per unit vary inversely with activity: As volume
increases, unit cost declines, and vice versa.

Examples:
Real estate taxes, Insurance, Supervisory salaries, Depreciation on
buildings and equipment and Advertising.
TOTAL FIXED COST

Your monthly basic cable bill probably does not

change regardless of how much viewing you do.
FIXED COST PER UNIT

The average cost per show decreases as more shows

are watched.
 Assume that Minton Inc. manufactures, bottles, and distributes
perfume. The production supervisor is Jane Sovissi, who is paid a
salary of $75,000 per year. For the relevant range of 50,000 to
300,000 bottles of perfume, the total fixed cost of $75,000 does not
vary as production increases. As a result, the fixed cost per bottle
decreases as the units produced increase.
Exhibit 2.1
 The trend for many manufacturers is to have more fixed costs
and fewer variable costs. This trend is the result of increased use of
automation and less use of employee labor. As a result, depreciation
and lease charges (fixed costs) increase, whereas direct labor costs
(variable costs) decrease.
MIXED COSTS

Mixed costs are costs that have characteristics of both a variable

and a fixed cost. Mixed costs are sometimes called semi-variable or
semi-fixed costs.
Mixed costs, therefore, change in total but not proportionately
with changes in the activity level.
Mixed costs contain a fixed cost component that is incurred even
if nothing is produced. For analysis, the fixed and variable cost
components of mixed costs are separated using the high-low
method.
Examples:
Quality Control Department salaries
Purchasing Department salaries
Maintenance expenses
Warehouse expenses
EXAMPLE # 1

Assume that Simpson Inc. manufactures sails, using

rented machinery. The rental charges are as follows:

Rental Charge = $15,000 per year + $1 for each hour

used in excess of 10,000 hours
Exhibit 3.1

The rental charges for various hours used within the

relevant range of 8,000 hours to 40,000 hours are as follows:
Exhibit 3.2 MIXED COSTS
EXAMPLE # 2

Assume sales personnel at Bikes Unlimited are paid a total of

$10,000 in monthly salary plus a commission of $7 for every bike
sold. This is a mixed cost because it has a fixed component of
$10,000 per month and a variable component of $7 per unit.
Table 3.1 Mixed Cost Behavior for Bikes Unlimited
Figure 3.3 Total Mixed Sales Compensation Costs
for Bikes Unlimited
Key Equation

Total mixed cost = Total fixed cost + (Unit variable cost

× Number of units)
Or
Y = f + vX

where Y = total mixed costs (this is the y-axis in Figure 5.3 "Total
Mixed Sales Compensation Costs for Bikes Unlimited")
f = total fixed costsv = variable cost per unit X = level of activity (this
is the x-axis in Figure 5.3 "Total Mixed Sales Compensation Costs for
Bikes Unlimited")
For Bikes Unlimited, the mixed cost equation is
Y = $10,000 + $7X.
If Bikes Unlimited sells 4,000 bikes (X) in one month, the
total mixed cost (Y) for sales personnel compensation
would be
$38,000 [= $10,000 + ($7 × 4,000 units)].
How Cost Behavior Patterns Are Used
Accurately predicting what costs will be in the future can help
managers answer several important questions. For example,
managers at Bikes Unlimited might ask the following:

 We expect to see a 5 percent increase in unit sales next year.

How will this affect revenues and costs?
 We are applying for a loan with a bank, and bank managers think
our sales estimates are high. What happens to our revenues and
costs if we lower estimates by 20 percent?
 What happens to revenues and costs if we add a racing bike to our
product line?
How Cost Behavior Patterns Are Used
 How will costs behave in the future if we increase automation
in the production process?

The only way to accurately predict costs is to understand how

costs behave given changes in activity. To make good decisions,
managers must know how costs are structured (fixed, variable, or
mixed).
CONTRIBUTION MARGIN
INCOME STATEMENT
FELICIDARIO, LENIE P.
What is Contribution Margin?

 is the amount of revenue remaining after deducting all variable

costs.
 in a traditional format, costs are classified by its functions like
Cost of Good Sold and Operating expenses. This format is primarily
used in external reporting or Financial Management.
 in Contribution Margin format, costs are classified by the way
they behave as to variable or fixed costs. This format is commonly
used in internal reporting by management.
You can easily see the similarities and differences, and
it shows the focus of each income statement method..
Contribution Margin Income Statement vs.
Traditional Income Statement

 It replaces gross margin.

 Fixed expenses are aggregated lower after contribution
margin.
 Variable expenses are a part of calculating the
contribution margin.
VARIABLE COSTS FIXED COSTS

 direct labor  building rent

 direct materials  equipment
 utility costs  salaries
 sales commissions  etc..
 etc..
Example!

Makabayan Bakery started its business and sold it’s best bread
product last December for P10.00 per piece. The fixed cost (building
rent) were P3,000.00 and fixed selling and admin costs were
P50,000.00. Variable product costs (direct labor, material, utility
cost) were P2.00 per unit and sales commission of P1.00. Makabayan
Bakery sold 10,000 units of bread.

Prepare Contribution Margin Income Statement.

 MAKABAYAN BAKERY
CONTRIBUTION MARGIN INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2020
Total Per unit Per Cm Ratio
Sales Revenue ₱ 100,000.00 ₱ 10.00 100%
Less: Variable costs
Cost of Good Sold 20,000.00 2.00 20%
Admin Costs 10,000.00 1.00 10%
Contribution Margin 70,000.00 ₱ 7.00 70%
Less: Fixed Costs
Rent 3,000.00
Salaries and wages 50,000.00
Operating Income/Loss ₱ 17,000.00
• Contribution Margin Ratio • Variable Costs Margin Ratio
• Contribution Margin / Sales • Variable Costs / Sales Revenue x
Revenue x 100% 100%

Sales Revenue 100,000.00 Sales Revenue 100,000.00

Less: Variable costs Less:
COGS 20,000.00 COGS 20,000.00
Admin Costs 10,000.00 Admin Costs 10,000.00
Contribution Margin 70,000.00 Variable Costs 30,000.00
Contribution Margin Ratio 70% Variable Costs Margin Ratio 30%
Changes in Fixed cost and Sales volume

What is the profit impact if Makabayan Bakery will increase unit

sales from 10,000 to 10,200 by adding monthly advertising budget
by P2,500.00?
Changes in Fixed cost and Sales volume

MAKABAYAN BAKERY
CONTRIBUTION MARGIN INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2020

Sales Revenue (10,200 units) 102,000.00

Less: Variable costs
Cost of Good Sold 20,000.00 Sales increased by P2,000.00,
Admin Costs 10,000.00 (30,000.00) but Net Operating Income
Contribution Margin 72,000.00 decreased by P500.00.
Less: Fixed Costs
Rent 3,000.00
Advertising costs 2,500.00
Salaries and wages 50,000.00 (55,500.00)
Operating Income/Loss ₱ 16,500.00
Changes in Variable cost and Sales volume

What is the profit impact if Makabayan Bakery will use higher

quality raw material of flour thus increasing variable cost per unit
by P1.00 to generate an increase in unit sales from 10,000 to
12,000?
 MAKABAYAN BAKERY
CONTRIBUTION MARGIN INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2020
10000 units 12000 units
Sales Revenue (10,000 units)
₱ 100,000.00 ₱ 120,000.00
Less: Variable costs Sales increased by P20,000.00
Cost of Good Sold
Admin Costs
20,000.00
10,000.00
30,000.00
10,000.00
and net operating income
Contribution Margin 70,000.00 80,000.00 increased by P10,000.00
Less: Fixed Costs
Rent 3,000.00 3,000.00
Salaries and wages 50,000.00 50,000.00
Operating Income/Loss ₱ 17,000.00 ₱ 27,000.00
 MAKABAYAN BAKERY
CONTRIBUTION MARGIN INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2020

Sales Revenue (8,000 units) 80,000.00

Less: Variable costs
Cost of Good Sold 20,000.00
Admin Costs 10,000.00 (30,000.00)
Contribution Margin 50,000.00
Less: Fixed Costs
Rent 3,000.00
Salaries and wages 50,000.00 (53,000.00)
Operating Income/Loss -₱ 3,000.00
Advantages:

• Data is placed in an organized manner, which helps the management to

understand how changes in production and sales volumes will affect the
profit.
• It helps in identifying variable expenses that are eating up too much of
the revenue.
• Even though the numbers remain the same, it gives a different
perspective of the current financial condition.
• Better analysis can be done as the fixed and variable expenses are
bifurcated.
• It can be used for break-even analysis.
Disadvantages / Limitations:

• The format is not recognized by GAAP and hence cannot

be shared with the external consumers of the financial
statements.

• It focuses only on the expenses side.

• The income statement is accessible only to the internal

audience.
Important Points:

• It depicts expenses based on its functional area.

• It distinguishes between fixed and variable expenses.
• The statement helps in decision making for the management. It is
helpful to managers in judging the impact on profits of changes in
selling price, cost, or volume. The emphasis is on cost behavior.
• With the help of the statement, we can conduct a break-even
analysis.
END OF PRESENTATION
THANK YOU !