Chapter 1 - Managerial Accounting and Cost Concepts PDF

Chapter 1 Managerial Accounting and Cost Concepts  1-2 Needs of Management Financial accounting is concerned with reporting financial information to external parties,...

Chapter 1 Managerial Accounting and Cost Concepts  1-2 Needs of Management Financial accounting is concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators. Managerial accounting is concerned with providing information to managers within an organization so that they can formulate plans, control operations, and make decisions. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-3 Purposes of Cost Classification 1. Assigning costs to cost objects 2. Accounting for costs in manufacturing companies 3. Preparing financial statements 4. Predicting cost behavior in response to changes in activity 5. Making decisions ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-4 Learning Objective 1 Understand cost classifications used for assigning costs to cost objects: direct costs and indirect costs. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-5 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 material Example: manufacturing and direct labor overhead A cost object is any item for which costs are being separately measured (ex: product, services / department, production line, process) ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-6 Learning Objective 2 Identify and give examples of each of the three basic manufacturing cost categories. *Manufacturing cost is the sum of costs of all resources consumed in the process of making a product. *Nonmanufacturing costs are costs that are not related to the production of goods. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-7 Classifications of Manufacturing Costs Direct Direct Manufacturing Materials Labor Overhead ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-8 Direct Materials Direct materials are 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 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-9 Direct Labor Direct labor costs are labor costs that can be easily traced to individual units of product. Example: Wages paid to automobile assembly workers ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-10 Manufacturing Overhead Manufacturing overhead includes all manufacturing costs except direct material and direct labor. These costs cannot be readily traced to finished products. Includes indirect materials Includes indirect labor costs that cannot be easily or that cannot be easily or conveniently traced to conveniently traced to specific units of product. specific units of product. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-11 Manufacturing Overhead – Examples Examples of manufacturing overhead: Depreciation of manufacturing equipment Utility costs – electricity, gas, water, etc Property taxes Insurance premiums incurred to operate a manufacturing facility Only those indirect costs associated with operating the factory are included in manufacturing overhead. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-12 Prime Costs and Conversion Costs Manufacturing costs are often classified as follows: Direct Direct Manufacturing Material Labor Overhead Prime Conversion Cost Cost ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-13 Nonmanufacturing Costs Selling Administrative Costs Costs Costs necessary to All executive, secure the order and organizational, and deliver the product. clerical costs. Selling costs can be Administrative costs either direct or indirect can be either direct or costs. indirect costs. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-14 Exercise For each cost, indicate whether it would be most likely to be classified as direct materials, direct labor, manufacturing overhead, selling, or administrative cost (Cost objective: computer) 1. The cost of a hard drive installed in a computer 2. The cost of advertising in the newspaper 3. The wages of employees who assemble computers from components 4. Sales commissions paid to the company’s salespeople 5. The salary of the assembly shop’s supervisor 6. The salary of the company’s accountant 7. Depreciation on equipment used to test assembled computers before release to customers ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-15 Learning Objective 3 Understand cost classifications used to prepare financial statements: product costs and period costs. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-16 Product Costs Product costs includes all the costs that are involved in acquiring or making a product. Product costs “attach” to a unit of product as it is purchased or manufactured and they stay attached to each unit of product as long as it remains in inventory awaiting sale. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-17 Manufacturing Product Costs For manufacturing companies, product costs include: Raw materials: includes any materials that go into the final product. Work in process: consists of units of product that are only partially complete and will require further work before they are ready for sale to the customer. Finished goods costs: consists of completed units of product that have not yet been sold to customers. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-18 Transfer of Product Costs When direct materials are used in production, their costs are transferred from Raw Materials to Work in Process. Direct labor and manufacturing overhead costs are added to Work in Process to convert direct materials into finished goods. Once units of product are completed, their costs are transferred from Work in Process to Finished Goods. When a manufacturer sells its finished goods to customers, the costs are transferred from Finished Goods to Cost of Goods Sold. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-19 Transfer of Product Costs ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-20 Cost Classifications for Preparing Financial Statements Product costs include direct Period costs include all materials, direct labor, and selling costs and manufacturing overhead. administrative costs. Inventory Cost of Good Sold Expense Sale Balance Income Income Sheet Statement Statement ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-21 Quick Check 1 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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-22 Quick Check 1a 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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-23 Learning Objective 4 Understand cost classifications used to predict cost behavior: variable costs, fixed costs, and mixed costs. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-24 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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-25 Variable Cost A cost that varies, in total, in direct proportion to changes in the level of activity. A variable cost per unit is constant. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-26 An Activity Base (Cost Driver) Units Machine produced hours A measure of what causes the incurrence of a variable cost Miles Labor driven hours ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-27 Fixed Cost A cost that remains constant, in total, regardless of changes in the level of the activity. If expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-28 Types of Fixed Costs Committed Discretionary Long-term, cannot May be altered in the be significantly short-term by current reduced in the short managerial decisions term ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-29 Comparison of 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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-30 Quick Check 2 Which of the following costs would be variable with respect to the number of ice cream cones sold at a Baskin & Robbins? (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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-31 Quick Check 2a Which of the following costs would be variable with respect to the number of ice cream cones sold at a Baskin & Robbins? (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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-32 Mixed Costs – Part 1 A mixed cost contains both variable and fixed elements. Consider the example of utility cost. Y Total Utility Cost Variable Cost per KW X Fixed Monthly Activity (Kilowatt Hours) Utility Charge ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-33 Mixed Costs – Part 2 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 Y vertical intercept of the line). b = The variable cost per unit of Total Utility Cost activity (the slope of the line). X = The level of activity. Variable Cost per KW X Fixed Monthly Activity (Kilowatt Hours) Utility Charge ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-34 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 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-35 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 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. Guided Example 1-36 Java Express operates a number of espresso coffee stands in busy suburban malls. The fixed weekly expense of a coffee stand is $1,500 and the variable cost per cup of coffee served is $0.19. Required: Estimate the total costs and average cost per cup of coffee at the indicated levels of activity for a coffee stand. Cups Cups of of Coffee Coffee Served Served in in aa Week Week 3,700 3,800 3,900 Fixed cost Variable cost Total cost Average cost per cup of coffee served [LO4] Guided Example 1-37 Java Express operates a number of espresso coffee stands in busy suburban malls. The fixed weekly expense of a coffee stand is $1,500 and the variable cost per cup of coffee served is $0.19. Required: Estimate the total costs and average cost per cup of coffee at the indicated levels of activity for a coffee stand. Cups Cups of of Coffee Coffee Served Served in in aa Week Week 3,700 3,800 3,900 Fixed cost $1,500 $1,500 $1,500 Variable cost 703 722 741 Total cost $2,203 $2,222 $2,241 Average cost per cup of coffee served $ 0.60 $ 0.58 $ 0.57 [LO4]  1-38 Learning Objective 5 Understand cost classifications used in making decisions: relevant costs and irrelevant costs. ©McGraw-Hill ©McGraw-Hill Education. Education. All All rights rights reserved. reserved. Authorized Authorized only only for for instructor instructor useuse in the in the classroom. classroom. No No reproduction reproduction or further or further distribution distribution permitted permitted withoutwithout the prior the written prior written consent consent of McGraw-Hill of McGraw-Hill Education. Education.  1-39 Cost Classifications for Decision Making Decisions involve choosing between alternatives. The goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision. To make decisions, it is essential to understand the concepts of differential costs and revenues, opportunity costs, and sunk costs. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-40 Differential Costs Differential costs (or incremental costs) are the difference in cost between any two alternatives. A difference in revenue between two alternatives is called differential revenue. Both are always relevant to decisions. Differential costs can be either fixed or variable. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-41 Opportunity Cost The potential benefit that is given up when one alternative is selected over another. These costs are not usually found in accounting records but must be explicitly considered in every decision. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-42 Sunk Costs Sunk costs have already been incurred and cannot be changed now or in the future. These irrelevant costs should be ignored when making decisions. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-43 Quick Check 3 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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-44 Quick Check 3a 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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-45 Quick Check 4 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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-46 Quick Check 4a 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. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-47 Learning Objective 6 Prepare income statements for a merchandising company using the traditional and contribution formats. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-48 The Traditional and Contribution Formats Used primarily for Used primarily by external reporting. management. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-49 Practice: Simply Snowplows Simply Snowplows manufactures and sells snowplows. The company assembled the information shown below for the quarter ended March 31. Note, the company has fixed MOH of $25,000 per quarter and fixed admin costs of $30,000 per quarter. Prepare the company’s tradition and contribution format income statements. What costs do we need to identify to create a tradition income statement? ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-50 Practice: Simply Snowplows Simply Snowplows manufactures and sells snowplows. The company assembled the information shown below for the quarter ended March 31. Note, the company has fixed MOH of $25,000 per quarter and fixed admin costs of $30,000 per quarter. Prepare the company’s tradition and contribution format income statements. What costs do we need to identify to create a tradition income statement? Period Costs Product Costs ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-51 Practice: Simply Snowplows Simply Snowplows manufactures and sells snowplows. The company assembled the information shown below for the quarter ended March 31. Note, the company has fixed MOH of $25,000 per quarter and fixed admin costs of $30,000 per quarter. Prepare the company’s tradition and contribution format income statements. What costs do we need to identify to create a contribution margin income statement? ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-52 Practice: Simply Snowplows Simply Snowplows manufactures and sells snowplows. The company assembled the information shown below for the quarter ended March 31. Note, the company has fixed MOH of $25,000 per quarter and fixed admin costs of $30,000 per quarter. Prepare the company’s tradition and contribution format income statements. What costs do we need to identify to create a contribution margin income statement? Fixed Costs Variable Costs ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.  1-53 Practice: Simply Snowplows ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. Guided Example 1-54 Hough Company manufactures and sells a single product. A partially completed schedule of the company’s total and per unit costs over a relevant range of 80,000 to 120,000 units produced and sold each year is given below: Units produced and sold 80,000 100,000 120,000 Total costs: Variable costs $240,000 Fixed costs 320,000 Total costs $560,000 Cost per unit: Variable cost Fixed cost Total cost per unit Required: 1. Complete the schedule of the company’s total and unit costs. 2. Assume that the company produces and sells 110,000 units during the year at the selling price of $6.50 per unit. Prepare a contribution format income statement for the year. [LO4, LO6] Guided Example 1-55 Requirement 1: Complete the schedule of total costs and unit costs. Units produced and sold 80,000 100,000 120,000 Total costs: Variable costs $240,000 $300,000 $360,000 Fixed costs 320,000 320,000 320,000 Total costs $560,000 $620,000 $680,000 Cost per unit: Variable cost $3.00 $3.00 $3.00 Fixed cost 4.00 3.20 2.67 Total cost per unit $7.00 $6.20 $5.67 Variable cost per unit = Total variable cost/Number of units Variable cost per unit = $240,000/80,000 units Variable cost per unit = $3.00/unit Guided Example 1-56 Requirement 2: Assume that the company produces and sells 110,000 units during the year at the selling price of $6.50 per unit. Prepare a contribution format income statement for the year. Hough Company Contribution Format Income Statement For the year Sales (110,000 units × $6.50 per unit) $715,000 Variable expenses (110,000 units × $3.00 per unit) 330,000 Contribution margin 385,000 Fixed expenses 320,000 Net operating income $ 65,000  1-57 Review of Cost Classification Systems Function Predicting Cost Behavior Relation to Manufacturing Costs Variable Costs Cost Objects Direct Materials Fixed Costs Direct Costs Direct Labor Mixed Costs Indirect Costs Manufacturing Overhead Nonmanufacturing Costs Selling Costs Administration Costs Preparing Financial Decision Making Statements Differential Costs (and Product Costs (inventoriable) Revenues) Period Costs (expensed) Opportunities Costs Sunk Costs ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.