1-1

Managerial Accounting and Cost

Concepts
Chapter 1
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

Copyright © 2015 by McGraw-Hill Education. All rights reserved.

 1-2

Summary of the Types of Cost

Classifications

Assigning Costs to Predicting Cost

Cost Objects Behavior

Financial Making Business

Reporting Decisions
 1-3

Learning Objective 1-1

Understand cost classifications

used for assigning costs to cost
objects: direct costs and
indirect costs.
 1-4

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 product traced to a unit of product
or other cost object. or other cost object.
• Examples: direct • Example: manufacturing
material and direct labor overhead

Common costs
Indirect costs incurred to support a number of
cost objects. These costs cannot be traced to
any individual cost object.
 1-5

Learning Objective 1-2

Identify and give examples

of each of the three basic
manufacturing cost
categories.
 1-6

Classifications of Manufacturing Costs

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

The Product
 1-7

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
 1-8

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
 1-9

Manufacturing Overhead
Manufacturing costs that cannot be easily
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. who are not directly
involved in production
Examples: lubricants and work.
cleaning supplies used in the Examples: maintenance
automobile assembly plant. workers, janitors, and
security guards.
 1-10

Nonmanufacturing Costs

Selling Administrative
Costs Costs

Costs necessary to secure the All executive, organizational,

order and deliver the product. and clerical costs.
Selling costs can be either Administrative costs can be
direct or indirect costs. either direct or indirect costs.
 1-11

Learning Objective 1-3

Understand cost
classifications used to
prepare financial
statements: product costs
and period costs.
 1-12

Cost Classifications for Preparing Financial

Statements

Product costs include Period costs include all

direct materials, direct selling costs and
labor, and manufacturing administrative costs.
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 1-13

Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company?
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.
 1-14

Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company?
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.
 1-15

Prime Costs and Conversion Costs

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

Prime Conversion
Cost Cost
 1-16

Learning Objective 1-4

Understand cost
classifications used to
predict cost behavior:
variable costs, fixed costs,
and mixed costs.
 1-17

Cost Classifications for Predicting Cost

Behavior
Cost behavior refers
to how a cost will
react to changes in
the level of activity.
The most common
classifications are:
▫ Variable costs.
▫ Fixed costs.
▫ Mixed costs.
 1-18

Variable Cost
A cost that varies, in total, in direct proportion to
changes in the level of activity. Your total texting bill
may be based on how many texts you send.
Total Texting Bill

Number of Texts Sent

 1-19

Variable Cost Per Unit

However, variable cost per unit is constant. The cost per text
sent may be constant at 5 cents per text message.

Cost Per Text Sent

Number of Texts Sent

 1-20

The Activity Base (Cost Driver)

Units Machine
produced hours

A measure of what
causes the
incurrence of a
variable cost

Miles Labor
driven hours
 1-21

Fixed Cost
A cost that remains constant, in total, regardless of changes in
the level of the activity. Your monthly contract fee for your
cell phone may be fixed for the number of monthly minutes in
your contract.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

Within Monthly Plan
 1-22

Fixed Cost Per Unit

However, if expressed on a per unit basis, the average fixed cost per unit varies
inversely with changes in activity. 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
 1-23

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 • Advertising
Buildings Equipment • Research and
• Real Estate Taxes Development
1-24
 1-25

The Linearity Assumption and the Relevant

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

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

Activity
 1-26

Fixed Costs and the Relevant Range

The relevant range of activity pertains to fixed cost as
well as variable costs. For example, assume office space
is available at a rental rate of $30,000 per year in
increments of 1,000 square feet.

Fixed costs would increase

in a step fashion at a rate of
$30,000 for each additional
1,000 square feet.
 1-27

Fixed Costs and the Relevant Range

90
Rent Cost in Thousands

The relevant range

Relevant of activity for a fixed
60
of Dollars

cost is the range of

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

0
0 1,000 2,000 3,000
Rented Area (Square Feet)
 1-28

Cost Classifications for Predicting Cost

Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost Increase Variable cost per unit

and decrease in proportion remains constant.
to changes in the activity level.
Fixed Total fixed cost is not affected Fixed cost per unit decreases
by changes in the activity as the activity level rises and
level within the relevant range. increases as the activity level falls.
 1-29

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.
 1-30

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.
 1-31

Mixed Costs
A
A mixed
mixed cost
cost contains
contains both
both variable
variable and
and fixed
fixed
elements.
elements. Consider
Consider the
the example
example of
of utility
utility cost.
cost.
Y
Total Utility Cost

os t
d c
ixe
al m
Tot
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 1-32

Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX

Where: Y = The total mixed cost.

a = The total fixed cost (the
vertical intercept of the line).
Y b = The variable cost per unit of
activity (the slope of the line).
X = The level of activity.
Total Utility Cost

os t
d c
ixe
al m
Tot
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 1-33

Mixed Costs – An Example

If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?

Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
 1-34

Analysis of Mixed Costs

Account Analysis and the Engineering Approach

In
In account
account analysis,
analysis, each
each account
account isis
classified
classified as
as either
either variable
variable or
or fixed
fixed based
based
on
on the
the analyst’s
analyst’s knowledge
knowledge of of how
how
the
the account
account behaves.
behaves.

The
The engineering
engineering approach
approach classifies
classifies
costs
costs based
based upon
upon an
an industrial
industrial
engineer’s
engineer’s evaluation
evaluation of
of production
production
methods,
methods, and
and material,
material, labor,
labor, and
and
overhead
overhead requirements.
requirements.
 1-35

Learning Objective 1-5

Analyze a mixed cost using

a scattergraph plot and the
high-low method.
 1-36

Scattergraph Plots – An Example

Assume the following hours of maintenance work
and the total maintenance costs for six months.
 1-37

The Scattergraph Method

Plot
Plot the
the data
data points
points on
on aa graph
graph (Total
(Total Cost
Cost YY “dependent
“dependent
variable”
variable” vs.
vs. Activity
Activity XX “independent
“independent variable”).
variable”).
Y Scattergraph Method
$10,000
Total Maintenance Cost

$9,500

$9,000

$8,500

$8,000

$7,500

$7,000 X
400 500 600 700 800 900

Hours of Maintenance
 1-38

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
 1-39

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
 1-40

The High-Low Method – An Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
 1-41

Quick Check 
Sales salaries and commissions are $10,000
when 80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the variable portion of sales
salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
 1-42

Quick Check 
Sales salaries and commissions are $10,000
when 80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the variable portion of sales
salaries and commission?
a. $0.08 per unit
b. $0.10 per unit $4,000 ÷ 40,000 units
c. $0.12 per unit = $0.10 per unit
d. $0.125 per unit
 1-43

Quick Check 
Sales
Sales salaries
salaries and
and commissions
commissions are are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the fixed
fixed portion
portion of
of sales
sales
salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.
c. $10,000
$10,000
d.
d. $12,000
$12,000
 1-44

Quick Check 
Sales
Sales salaries
salaries and
and commissions
commissions are are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 whenwhen
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the fixed
fixed portion
portion of
of sales
sales
salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000 Total cost = Total fixed cost +
b.
b. $$ 4,000
4,000 Total variable cost

c.
c. $10,000
$10,000 $14,000 = Total fixed cost +
($0.10 × 120,000 units)
d.
d. $12,000
$12,000
Total fixed cost = $14,000 - $12,000
Total fixed cost = $2,000
 1-45

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.
 1-46

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.
 1-47

Comparing Results From

the Two Methods
The
The two
two methods
methods just
just discussed
discussed provide
provide
different
different estimates
estimates of
of the
the fixed
fixed and
and variable
variable cost
cost
components
components of of aa mixed
mixed cost.
cost.
This
This is
is to
to be
be expected
expected because
because each
each method
method
uses
uses differing
differing amounts
amounts of
of the
the data
data points
points to
to
provide
provide estimates.
estimates.
Least-squares
Least-squares regression
regression provides
provides the
the most
most
accurate
accurate estimate
estimate because
because itit uses
uses all
all the
the data
data
points.
points.
 1-48

Learning Objective 1-6

Prepare income statements

for a merchandising
company using the
traditional and
contribution formats.
 1-49

The Traditional and Contribution Formats

Comparison of the Contribution Income Statement

with the Traditional Income Statement

Traditional Format Contribution Format

Sales $ 100,000 Sales $ 100,000

Cost of goods sold 70,000 Variable expenses 60,000
Gross margin $ 30,000 Contribution margin $ 40,000
Selling & admin. expenses 20,000 Fixed expenses 30,000
Net operating income $ 10,000 Net operating income $ 10,000

Used primarily for Used primarily by

external reporting. management.
 1-50

Uses of the Contribution Format

The
The contribution
contribution income
income statement
statement format
format is
is used
used
as
as an
an internal
internal planning
planning andand decision-making
decision-making tool.
tool.
We
We will
will use
use this
this approach
approach for:
for:
1.Cost-volume-profit
1.Cost-volume-profit analysis
analysis (Chapter
(Chapter 5).
5).
2.Budgeting
2.Budgeting (Chapter
(Chapter 7).
7).
3.Segmented
3.Segmented reporting
reporting of
of profit
profit data
data (Chapter
(Chapter 6).
6).
4.Special
4.Special decisions
decisions such
such as
as pricing
pricing and
and make-or-
make-or-
buy
buy analysis
analysis (Chapter
(Chapter 10).
10).
 1-51

Learning Objective 1-7

Understand cost
classifications used in
making decisions:
differential costs,
opportunity costs, and sunk
costs.
 1-52

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 in a decision. All other
costs and benefits can and should be
ignored as irrelevant.
 1-53

Differential Cost and Revenue

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
 1-54

Opportunity Cost
The potential benefit that is given
up when one alternative is
selected over another.
These costs are not
usually entered into the
accounting records of an
organization, but must be
explicitly considered in all
decisions.

What are the opportunity

costs you incur to attend this
class?
 1-55

Sunk Costs

Sunk costs have already been incurred and

cannot be changed now or in the future.
These costs should be ignored when making
decisions.

Example: Suppose you had purchased gold for

$1,100 an ounce, but now it is selling for $950 an
ounce. Should you wait for the gold to reach $1,100
an ounce before selling it? You may say, “Yes” even
though the $1,100 purchase is a sunk cost.
 1-56

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.
 1-57

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.
 1-58

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.
 1-59

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.
 1-60

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.
 1-61

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.
 1-62

End of Chapter 1