Managerial Accounting and Cost
Concepts
Chapter 1
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Learning Objective 1
Identify and give
examples of each of the
three basic
manufacturing cost
categories.
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Classifications of Manufacturing Costs
Direct Direct Manufacturing
Materials Labor Overhead
The Product
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Direct Materials
Raw materials that become an integral
part of the product and that can be
conveniently traced directly to it.
Example: A radio installed in an automobile
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Direct Labor
Those labor costs that can be easily
traced to individual units of product.
Example: Wages paid to automobile assembly workers
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Manufacturing Overhead
Manufacturing costs that cannot be easily
traced directly to specific units produced.
Examples: Indirect materials and indirect 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.
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Nonmanufacturing Costs
Selling Administrative
Costs Costs
Costs necessary to All executive,
secure the order and organizational, and
deliver the product. clerical costs.
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Learning Objective 2
Distinguish between
product costs and period
costs and give examples
of each.
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Product Costs Versus Period Costs
Product costs include Period costs include all
direct materials, direct selling costs and
labor, and administrative costs.
manufacturing
overhead.
Inventory Cost of Good Sold Expense
Sale
Balance Income Income
Sheet Statement Statement
2-10
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.
2-11
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.
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Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct Direct Manufacturing
Material Labor Overhead
Prime Conversion
Cost Cost
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Learning Objective 3
Understand cost
behavior patterns
including variable costs,
fixed costs, and mixed
costs.
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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.
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Variable Cost
Your total texting bill is based on how
many texts you send.
Total Texting Bill
Number of Texts Sent
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Variable Cost Per Unit
The cost per text sent is constant at
5 cents per text message.
Cost Per Text Sent
Number of Texts Sent
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The Activity Base (Cost Driver)
Units Machine
produced hours
A measure of what
causes the
incurrence of a
variable cost
Miles Labor
driven hours
2-18
Fixed Cost
Your monthly contract fee for your cell phone is
fixed for the number of monthly minutes in your
contract. The monthly contract fee does not
change based on the number of calls you make.
Monthly Cell Phone
Contract Fee
Number of Minutes Used
Within Monthly Plan
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Fixed Cost Per Unit
Within the monthly contract allotment, 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
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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 Buildings Advertising and
and Equipment and Real Research and
Estate Taxes Development
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The Linearity Assumption and the Relevant
Range
Economist’s A straight line
closely
Curvilinear Cost approximates a
Function curvilinear
variable cost
line within the
Relevant
relevant range.
Total Cost
Range
Accountant’s Straight-Line
Approximation (constant
unit variable cost)
Activity
2-22
Fixed Costs and the Relevant Range
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.
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Fixed Costs and the Relevant Range
90
Rent Cost in Thousands
The relevant range
Relevant of activity for a fixed
of Dollars
60 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)
2-24
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.
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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.
2-26
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.
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Learning Objective 4
Prepare income
statements for a
merchandising company
using the traditional and
contribution formats.
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The Traditional and Contribution Formats
Used primarily for Used primarily by
external reporting. management.
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Uses of the Contribution Format
The contribution income statement format is used
as an internal planning and decision-making tool.
We will use this approach for:
1.Cost-volume-profit analysis (Chapter 5).
2.Budgeting (Chapter 8).
3.Segmented reporting of profit data (Chapter 6).
4.Special decisions such as pricing and make-or-
buy analysis (Chapter 12).
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Learning Objective 5
Understand the differences
between direct and indirect
costs.
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Assigning Costs to Cost Objects
Direct costs Indirect costs
• Costs that can be • Costs that cannot
easily and be easily and
conveniently traced conveniently traced
to a unit of product to a unit of product
or other cost object. or other cost object.
• Examples: direct • Example:
material and direct manufacturing
labor overhead
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Learning Objective 6
Understand cost
classifications used in
making decisions:
differential costs,
opportunity costs, and
sunk costs.
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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.
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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
2-35
Opportunity Cost
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.
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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
$400 an ounce, but now it is selling for $250 an
ounce. Should you wait for the gold to reach $400 an
ounce before selling it? You may say, “Yes” even
though the $400 purchase is a sunk costs.
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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.
2-38
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.
2-39
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.
2-40
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.
2-41
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.
2-42
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.
2-43
Summary of the Types of Cost
Classifications
Financial Predicting Cost
Reporting Behavior
Assigning Costs Making Business
to Cost Objects Decisions
2-44
End of Chapter 1
