Managerial Accounting and Cost Concepts

Chapter 02

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Users of accounting information

Investors
Board of managements Middle managers

Tax authorities

Creditors

Bottom line managers Company

Public

Employees

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Managerial Accounting vs. Financial Accounting

Managerial accounting provides information for managers inside an organization who direct and control its operations. Financial accounting provides information to stockholders, creditors and others who are outside the organization.

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Financial Accounting vs. Managerial Accounting

Financial Accounting
1. Users 2. Time focus 3. Verifiability versus relevance 4. Precision versus timeliness 5. Subject 6. Rules 7. Requirement External persons who make financial decisions Historical perspective Emphasis on objectivity and verifiability Emphasis on precision Primary focus is on companywide reports Must follow GAAP / IFRS and prescribed formats Mandatory for external reports

Managerial Accounting
Managers who plan for and control an organization Future emphasis Emphasis on relevance Emphasis on timeliness Focus on segment reports Not bound by GAAP / IFRS or any prescribed format Not Mandatory

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Work of Management
Planning

Directing and Motivating

Controlling

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Planning and Control Cycle

Formulating longand short-term plans (Planning) Comparing actual to planned performance (Controlling)

Begin

Decision Making

Implementing plans (Directing and Motivating)

Measuring performance (Controlling)

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Cost classifications by:

Functions
Behaviors

Traceability Relevance

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Cost classification by functions

A. Manufacturing costs (Product costs). B. Non-manufacturing costs (period costs).

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Classifications of Manufacturing Costs

Direct Materials Direct Labor Manufacturing 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 the production process.

Examples: lubricants and cleaning supplies used in the automobile assembly plant.

Wages paid to employees who are not directly involved in production work.
Examples: maintenance workers, janitors, and security guards.

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

Prime Cost

Conversion Cost

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Nonmanufacturing Costs
Selling Costs Administrative Costs

Costs necessary to secure the order and deliver the product.

All executive, organizational, and clerical costs.

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Quick Check
Which of the following costs would be considered manufacturing overhead at Boeing? (More than one answer may be correct.)
A. Depreciation on factory forklift trucks. B. Sales commissions. C. The cost of a flight recorder in a Boeing 767. D. The wages of a production shift supervisor.

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Product Costs Versus Period Costs

Product costs include direct materials, direct labor, and manufacturing overhead.
Inventory Sale
Cost of Good Sold

Period costs include all selling costs and administrative costs.

Expense

Balance Sheet

Income Statement

Income Statement

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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.

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Manufacturing Cost Flows

Costs

Balance Sheet Inventories

Income Statement Expenses

Material Purchases Direct Labor Manufacturing Overhead

Raw Materials Work in Process

Finished Goods
Period Costs

Cost of Goods Sold

Selling and Administrative

Selling and Administrative

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Quick Check
Which of the following transactions would immediately result in an expense? (There may be more than one correct answer.)
A. Work in process is completed. B. Finished goods are sold. C. Raw materials are placed into production. D. Administrative salaries are accrued and paid.

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Example 1
AQUAS is a bottled water producer. It was established on Oct. 1, 2013. Clever Man the companys accountant is required to prepare an income statement to report on the first quarter performance.
AQUAS Income Statement For the quarter ended Dec. 31, 2013 (in VND mil.) 1. Sales 800 2. Expenses Materials purchased 200 Wages for workers 100 Wages for marketing staff 50 Salaries for office clerks 60 Payment for Advertising 150 Plant rent 55 Office rent 65 Payment for office utility 120 Payment for plant utility 180 Total expenses 980 20 3. Loss (180)

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Cost Classifications by Behaviors

Behavior of Cost (within the relevant range)
Cost Variable In Total Total variable cost changes as activity level changes. Total fixed cost remains the same even when the activity level changes. Per Unit Variable cost per unit remains the same over wide ranges of activity. Fixed cost per unit goes down as activity level goes up.

Fixed

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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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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
Long-term, cannot be significantly reduced in the short term.

Discretionary
May be altered in the short-term by current managerial decisions

Examples
Depreciation on Buildings and Equipment and Real Estate Taxes

Examples
Advertising and Research and Development

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The Linearity Assumption and the Relevant Range

Economists Curvilinear Cost Function
Relevant Range
A straight line closely approximates a curvilinear variable cost line within the relevant range.

Total Cost

Accountants Straight-Line Approximation (constant unit variable cost) Activity

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Mixed Costs
The total mixed cost line can be expressed as an equation: Y = a + bX
Where: Y a b X = The total mixed cost. = The total fixed cost (the vertical intercept of the line). = The variable cost per unit of activity (the slope of the line). = The level of activity.

Y Total Utility Cost

Variable Cost per KW

X Activity (Kilowatt Hours)

Fixed Monthly
Utility Charge

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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.

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Quick Check
Which of the following costs would be variable with respect to the number of people who buy a ticket for a show at a movie theater? (There may be more than one correct answer.)
A. The cost of renting the film. B. Royalties on ticket sales. C. Wage and salary costs of theater employees. D. The cost of cleaning up after the show.

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Income statement under contribution format

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Income statement under contribution format

Total $ 100,000 60,000 $ 40,000 30,000 $ 10,000 per unit $ 50 30 $ 20

Sales Variable costs Contribution margin Fixed costs Net Income

The contribution format focuses on the relationship between costs and activity level. Contribution margin will cover fixed costs and generate income.

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Cost classification by traceability

Direct costs
Costs that can be easily and conveniently traced to a unit of product or other cost objective. Examples: direct material and direct labor

Indirect costs
Costs cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead

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Cost classification by relevance

1. Differential cost. 2. Sunk cost. 3. Opportunity cost.

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Differential cost
Costs and revenues that differ among alternatives.
In 2013, Honda Vietnam established Asimo robots used for assembling motobikes. Their costs are VND 2.1 billions and their estimated useful life is 6 years.

There is a new Asimo version which is much better than the old ones: if Honda Vietnam uses the new version, the company will save 70% annual operating expenses.
The new versions price is VND 4 billions and its useful life is 5 years. The current robotss disposal value is VND 1 billion. Honda Vietnams current annual operating expenses are VND900 millions. Should Honda Vietnam buy the new version?

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Sunk Costs
Sunk costs inccured in the past and cannot be changed by any decision. They are not differential costs and should be ignored when making decisions.

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Opportunity Costs
The potential benefit that is given up when one alternative is selected over another.

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Example 2
Ennerdale Ltd has been asked to quote a price for a one-off contract. The company's management accountant has asked for your advice on the relevant costs for the contract. The following information is available:

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Materials
The contract requires 3,000 kg of material K, which is a material used regularly by the company in other production. The company has 2,000 kg of material K currently in stock which had been purchased last month for a total cost of 19,600. Since then the price per kilogram for material K has increased by 5%. The contract also requires 200 kg of material L. There are 250 kg of material L in stock which are not required for normal production. This material originally cost a total of 3,125. If not used on this contract, the stock of material L would be sold for 11 per kg.

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Labour
The contract requires 800 hours of skilled labour. Skilled labour is paid 9.50 per hour. There is a shortage of skilled labour and all the available skilled labour is fully employed in the company in the manufacture of product P. The following information relates to product P: per unit Selling price 100 Less Skilled labour 38 Other variable costs 22

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End of Chapter 02