Basic Managerial Accounting Concepts

Prof. Pamela GonzalezSource: Cornerstones of Managerial Accounting, 5e

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, they are said to expire. Expired costs are called expenses.Accumulating costs is the way that

costs are measured and recorded.

Assigning costs is the way that a cost is linked to some cost object.

A cost object is any item such as a product, customer, department, project, geographic region or plant, for which costs are measured and assigned.

Direct costs are costs that can be easily and accurately traced to a cost object

Indirect costs are costs that cannot be easily and accurately traced to a cost object.

Categories of costsVariable cost: A variable cost is one that increases in total as output increases and decreases in total as output decreases.

Fixed cost: A fixed cost is a cost that does not increase in total as output increases and does not decrease in total as output decreases.

Opportunity cost: An opportunity cost is the benefit given up or sacrificed when one alternative is chosen over another.

Products and Services

Products are goods produced by

converting raw materials through the

use of labor and indirect manufacturing resources, such as the manufacturing plant, land, and machinery.

Services are tasks or activities performed for a customer or an activity performed

using an organization’s products or facilities.

Total product post = Direct materials cost + Direct

labor cost + Manufacturing overhead

costPer-unit Cost = Total Product Cost ÷ Number

of Units Produced

Prime cost = Direct materials + Direct labor

Conversion cost = Direct labor + Manufacturing Overhead

Period costs are all costs that are not product costs

Selling costs, Administrative Costs, Costs of Goods Manufacture and Cost of Goods Sold.

Cost BehaviorProf. Pamela Gonzalez

Source: Cornerstones of Managerial Accounting, 5e

Cost behavior is the foundation upon which managerial accounting is built.

Costs can be variable, fixed, or mixed

A cost that does not change in total as output changes is a fixed cost.

A variable cost, on the other hand, increases in total with an increase in output and decreases in total with a decrease in output.

A cost driver is a causal factor that measures the output of the activity that leads (or causes) costs to change.

Relevant range is the range of output over which the assumed cost relationship is valid for the normal operations of a firm

Fixed Costs

Discretionary fixed costs are fixed costs that can be changed or avoided easily at management discretion. For example, advertising costs. Committed fixed costs, on the other hand, are fixed costs that cannot be easily changed. For example, lease costs.

Variable Costs

Step Costs: Narrow Steps

Some cost functions may be discontinuous.

Displays a constant level of cost for a range of output and then jumps to a higher level (or step) of cost at some point, where it remains for a similar range of output

Step Costs: Wide Steps

Three methods of separating a mixed cost into its fixed and variable components

Total cost = Fixed cost + (Variable rate x Output)

The dependent variable is a variable whose value depends on the value of another variable.

The independent variable measures output and explains changes in the cost or other dependent variable.

The intercept corresponds to fixed cost.

The slope of the cost line corresponds to the variable rate.

The high-low method is method of separating mixed costs into fixed and variable components by using just the high and low data points.

The scattergraph method is a way to see the cost relationship by plotting the data points on a graph.

The method of least squares (regression) is a statistical way to find the best-fitting line through a set of data points.

Cost-Volume-Profit Analysis

Prof. Pamela GonzalezSource: Cornerstones of Managerial Accounting, 5e

Cost-volume-profit (CVP) analysis estimates how changes in the following three factors affect a company’s profit,

• Costs (both variable and fixed)• Sales volume• Price

Direct materials

Direct labor

Variable overhea

d

Variable selling and administrative costs

Fixed selling and administrative costsFixed

overhead

The break-even point is the point where total revenue equals total cost

The margin of safety is the units sold or the revenue earned above the break-even volume.

Job-Order Costing Prof. Pamela Gonzalez

Source: Cornerstones of Managerial Accounting, 5e

Job – Order EnvironmentCustomized or built-to-order products

fit into this category, as do services that vary from customer to customer.

A job is one distinct unit or set of

units.

Two ways are commonly used to measure the costs associated with production: actual costing and normal costing.

In an actual cost system, only actual costs of direct materials, direct labor, and overhead are used to determine unit cost.

A normal cost system determines unit cost by adding actual direct materials, actual direct labor, and estimated overhead.

Importance of Unit Costs

Unit cost is a critical piece of information for a manufacturer.

Unit costs are essential for valuing inventory, determining income, and making numerous important decisions.

Process Costing Prof. Pamela Gonzalez

Source: Cornerstones of Managerial Accounting, 5e

Each product within a line passing through the processes would receive similar ‘‘doses’’ of materials, labor, and overhead costs.

Process costing works well whenever homogeneous products pass through a series of processes and receive similar amounts of manufacturing costs.

Types of Processes,

Sequential processing requires that units pass through one process before they can be worked

on in the next process in the sequence.

Parallel processing is another processing pattern that requires two or more sequential processes to produce a finished good.

Activity-Based Costing and Management

Prof. Pamela GonzalezSource: Cornerstones of Managerial Accounting, 5e

Continuous Improvement

Total Quality Management

Intense worldwide competition

Sophisticated Technology

Total Customer Satisfaction

-Increasing competitive pressures

Small profit margins

Product cost distortions can be damaging,particularly for those firms whose business environment is characterized by :

Categorizing Costs under ABC

Activity-Based Customer CostingKnowing how much it costs to service

different customers can be vital information for the following purposes:

setting pricingdetermining customer miximproving profitability

Customer-driven activities such as order entry, order picking, shipping etc.; are identified and listed in an activity dictionary.The cost of the resources consumed is assigned to activities, and the cost of the activities is assigned to individual customers.

Process Value AnalysisActivity-based management is a system-wide, integrated approach that focuses management’s attention on activities with the objective of improving customer value and profit achieved by providing this value. Process value analysis focuses

on cost reduction instead of cost assignment and emphasizes the maximization of system-wide performance.

Driver analysis is the effort expended to identify those factors that are the root causes of activity costs. Activity analysis is the process of

identifying, describing, and evaluating the activities that an organization performs.

Prof. Pamela GonzalezSource: Cornerstones of Managerial Accounting, 5e

Absorption and Variable Costing, and Inventory

Management

Absorption costing assigns all manufacturing costs to the product.

Direct materials, direct labor, variable overhead, and fixed overhead define the cost of a product.

Under this method, fixed overhead is assigned to the product through the use of a predetermined fixed overhead rate and is not expensed until the product is sold. Variable costing stresses the

difference between fixed and variable manufacturing costs.Variable costing assigns only variable manufacturing costs to the product; these costs include direct materials, direct labor, and variable overhead. Fixed overhead is treated as a period expense and is excluded from the product cost.

The relationship between variable-costing income and absorption-costing income changes as the relationship between production and sales changes.

Evaluating Profit-Center Managers

The evaluation of managers is often tied to the profitability of the units that they control.

If income performance is expected to reflect managerial performance, then managers have the right to expect the following:

As sales revenue increases from one period to the next, all other things being equal, income should increase.As sales revenue decreases from one period to the next, all other things being equal, income should decrease.

Questions!