Chapter 1&2

An Introduction to Managerial
Accounting and Cost Concepts

McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
1-2

Work of Management

Planning
Planning
Directing
Directing and
and
Motivating
Motivating

Controlling
Controlling
1-3

Planning

Identify
Identify
alternatives.
alternatives.

Select
Select alternative
alternative that
that does
does
the
the best
best job
job of
of furthering
furthering
organization’s
organization’s objectives.
objectives.

Develop
Develop budgets
budgets to
to guide
guide
progress
progress toward
toward the
the
selected
selected alternative.
alternative.
1-4

Directing and Motivating

Directing and motivating involves managing day-

to-day activities to keep the organization running
smoothly.
 Employee work assignments.
 Routine problem solving.
 Conflict resolution.
 Effective communications.
1-5

Controlling

The
The control
control function
function ensures
ensures
that
that plans
plans are
are being
being followed.
followed.

Feedback
Feedback inin the
the form
form ofof performance
performance reports
reports
that
that compare
compare actual
actual results
results with
with the
the budget
budget
are
are an
an essential
essential part
part of
of the
the control
control function.
function.
1-6

Planning and Control Cycle

Formulating
Formulatinglong-
long- Begin
and
andshort-term
short-termplans
plans
(Planning)
(Planning)

Comparing
Comparingactual
actual Implementing
Implementing
to
toplanned
planned Decision plans
performance Making plans(Directing
(Directing
performance and
(Controlling) andMotivating)
Motivating)
(Controlling)

Measuring
Measuring
performance
performance
(Controlling)
(Controlling)
1-7
Comparison of Financial and
Managerial Accounting
1-8

Learning Objective 1

Identify and give examples of

each of the three basic
manufacturing cost
categories.
1-9

Manufacturing Costs

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

The Product
1-10

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
1-11

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
1-12

Manufacturing Overhead

Manufacturing costs cannot be 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.
1-13

Classifications of Nonmanufacturing Costs

Administrative
Selling Costs
Costs

Costs necessary to get All executive,

the order and deliver organizational, and
the product. clerical costs.
1-14

Learning Objective 2

Distinguish between
product costs and period
costs and give examples
of each.
1-15

Product Costs Versus Period Costs

Product costs include Period costs are not

direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Cost of
Inventory Goods Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
1-16

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.
1-17

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.
1-18

Prime Cost and Conversion Cost

Manufacturing costs are often

classified as follows:

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Material
Material Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost
1-19
Comparing Merchandising and
Manufacturing Activities
Merchandisers . . . Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.

MegaLoMart
1-20

Balance Sheet

Merchandiser Manufacturer
Current Assets Current Assets
 Cash ❖ Cash
 Receivables ❖ Receivables
 Prepaid Expenses ❖ Prepaid Expenses
 Merchandise ❖ Inventories:
Inventory 1. Raw Materials
2. Work in Process
3. Finished Goods
1-21

Balance Sheet

Merchandiser Manufacturer
Current Assets Current Assets
 Cash ❖ Cash
 Receivables ❖ Receivables
Materials waiting to
 Prepaid Expenses Prepaid
❖ be Expenses
processed.
 Merchandise
Partially complete ❖ Inventories:
Inventory
products – some 1. Raw Materials
material, labor, or 2. Work in Process
overhead has been
3. Finished Goods
added.
Completed products
awaiting sale.
1-22

Learning Objective 5

Define and give

examples of variable
costs and fixed costs.
1-23
Cost Classifications for Predicting Cost
Behavior

How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
business
business activity.
activity.
 Total
 Total variable
variable costs
costs
change
change when
when activity
activity
changes.
changes.
 Total
 Total fixed
fixed costs
costs remain
remain
unchanged
unchanged when
when activity
activity
changes.
changes.
1-24

Total Variable Cost

Your total long distance telephone bill is

based on how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
1-25

Variable Cost Per Unit

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
1-26

Total Fixed Cost

Your monthly basic telephone bill

probably does not change when you
make more local calls.
Telephone Bill
Monthly Basic

Number of Local Calls

1-27

Fixed Cost Per Unit

The average fixed cost per local call

decreases as more local calls are made.

Monthly Basic Telephone

Bill per Local Call
Number of Local Calls
1-28
Cost Classifications for Predicting Cost
Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
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

Learning Objective 6

Define and give

examples of direct and
indirect costs.
1-32

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 traced to a unit of
product or other cost product or other cost
object. object.
 Examples: Direct  Example: Manufacturing
material and direct labor overhead
1-33

Learning Objective 7

Define and give examples of

cost classifications used in
making decisions: differential
costs, opportunity costs, and
sunk costs.
1-34

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 to the
decision. All other
costs and benefits can
and should be ignored.
1-35

Differential Costs and Revenues

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

Net Differential Benefit is:

$200
1-36

Opportunity Costs

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.
1-37

Sunk Costs

Sunk costs cannot be changed by

any decision. They are not
differential costs and should be
ignored when making decisions.
Example: You bought an automobile that cost
$10,000 two years ago. The $10,000 cost is
sunk because whether you drive it, park it, trade
it, or sell it, you cannot change the $10,000 cost.
1-38

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.
1-39

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 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.
1-40

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.
1-41

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.
1-42

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.
1-43

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.
1-44
Summary of the Types of Cost
Classifications
Predicting
Financial
Cost
Reporting
Behavior

Assigning
Decision
Costs to
Making
Cost Objects
1-45

End of Chapter 1&2