Introduction to Managerial
Accounting
UGBA102B
Lecture 3
John Briginshaw
Quick Check ✓
• Halleys.com is a new manufacturing company that
wants help working out its costs. Costs consists of
manufacturing costs ($1m plus $2 per unit) and sales
costs ($200,000 salaries and $1 per unit commission).
The company started last year, and made 2m units, of
which 1.7m were sold. What were the year’s costs?
PRODUCTION
SALES
Focus on costs (not
a. $4.4m
$1.9m
expenses) but (bonus
b. $5m
$1.9m
question!) what would
c. $4.4m
$2.2m
be the cost of goods
sold for the year?
d. $5m
$2.2m
Lecture 3 Agenda
Chapter 1: Quirks of variable and fixed costs
Chapter 1: Incremental costs
Chapter 2: What’s Job Order Costing?
Introduction to next topics
Topics – Chapter 1 wrap-up
• What cost classifications do I use for
different management purposes?
Purpose
Cost classification
Chapter
Assigning costs to cost objects
(without excessive administration)
Direct vs Indirect
Reporting under US GAAP
Product vs Period
Predicting cost behavior as volume
increases
Variable vs Fixed
5
Making decisions on short and long
time frames
Differential cost (changes
between choices) or not
12-13
Analyze fixed & variable costs vs Activity…
UNIT COST
BEHAVIOR
Cost per unit
Total cost
VARIABLE
COSTS
TOTAL COST
BEHAVIOR
Volume
Cost per unit
Total Cost
FIXED
COSTS
Volume
Volume
Volume
Total Costs and Profit can be
modeled as a function of volume
• Fixed costs are constant, $F
• Variable costs per unit are constant, UVC
• Therefore total costs can be calculated as
Total Costs, TC = F + UVC x Q
Where Q is the number of units
• Subtract TC from Revenue to get Operating
Profit (Unit CM = price – UVC)
Profit = Unit CM x Q - F
Quirks and features (I)
• Costs which are variable but non linear
– Procedure: Include these in the cost equation by
using a linear approximation to the cost curve
Total Cost
Economist’s
Curvilinear Cost
Function
Relevant
Range
Accountant’s Straight-Line
Approximation (constant unit
variable cost)
Activity
Quirks and features (II)
• Unit Costs depend on volume
▪ Unit cost = Total manufacturing cost
Number of units manufactured
▪ Often used for pricing but if there are fixed
costs, it is dependent on volume
• If pricing is determined using a high volume (low
fixed cost per unit) and sales is disappointing, then
company may make an unexpected loss
• If pricing is determined based on a low volume (this
means unit cost is at the high end), then price may
be too high to maximize sales
Quirks and Features (III)
• Fixed costs may “step up” as capacity limits
are reached
Quick Check
• Padmans Inc gives the following information for
activity level 10,000 units:
▪ Variable costs $10,000
▪ Fixed costs $50,000 per plant of 20,000 units capacity
• What are the unit costs at these three levels of
production?
10K units 20K
25K
A.
B.
C.
D.
$6
$6
$6
$5
$3.50
$3.50
$4.50
$3.50
$2.50
$5
$6.50
$5
Quirks and features (IV)
• Mixed costs
– These exhibit characteristics of both variable
and fixed costs
– Procedure: Analyze the mixed costs to break
out their fixed and variable portions, then
include in cost equation
Analyzing Mixed Costs
• Mixed costs have both
variable and fixed
components
• Part of a mixed cost changes
with volume or usage
• Part is fixed over a particular
period
• Can we incorporate the costs
into our analysis?
Mixed Costs – Preview Ch 5A
• For analysis, mixed costs must be divided
into their variable and fixed components
– These components can then be grouped with
other variable and fixed costs in calculations
• Methods used to separate mixed costs into
variable and fixed components
1. High-low method
2. Scatter diagram method (visual
determination of relationship)
3. Statistical methods such as least squares
Quick Check
• Hanbridge Inc. observes a mixed cost at two
activity levels. The cost is $2000 when 100
units are produced and $3000 at 200 units.
What is the variable cost per unit?
A.
B.
C.
D.
$5
$10
$15
$20
Traditional vs Contribution
Income Statements
• The normal income statement calculates
– Gross margin = Sales – COGS (product costs)
– Net income = Gross margin – period costs
• The contribution or variable costing income
statement focuses on variable vs fixed not
product vs period
– Contribution margin = Sales – Variable costs
– Net income = Contribution margin – Fixed costs
Traditional and Contribution
Income Statements - Example
Used primarily for
external reporting.
Used primarily by
management.
Quick Check
• In the previous slide, what is the
contribution margin ratio (as a percentage
of sales)?
A.
B.
C.
D.
10%
30%
40%
60%
Net Operating Income
• Net operating income is the same under
traditional and contribution formats for the
example on the previous slide and on pp. 39
• This is true for any merchandising company
and for a manufacturing company which
does not have any change in inventory
• (This assumption is relaxed in later chapters)
Contribution Format - usefulness
• Contribution format statements are more
useful for decision making because they
encourage maximization of contribution
margin
• If fixed costs are constant, maximum
contribution leads to maximum profit
• (However, fixed costs are only fixed with
respect to activity. A decision, such as a
plant closure, could decrease fixed costs)
Lecture 3 Agenda
Chapter 1: Quirks of variable and fixed costs
Chapter 1: Incremental costs
Chapter 2: What’s Job Order Costing?
Introduction to next topics
What is Differential Cost
Analysis? (E1-16)
• Differential cost analysis (also called
incremental analysis or relevant cost
analysis) looks only at the differential or
relevant effects of a decision between action
A and action B
– Only focus on revenues or costs which change
– Costs or revenues which stay the same whether
we choose A or B, are ignored
Intrinsic Motivators – Gaining
new understanding
• How can we
optimize CVP?
Credit: Garrison et al 16e
• How will we make
decisions if there are
sunk costs?
The analysis uses the differential cost
and opportunity cost concepts
• Irrelevant revenue or cost
– Revenues/costs that will not differ between
alternatives
– Sunk costs are irrelevant costs: Costs that were
incurred because of a previous decision and
cannot be recovered through the current decision
• Opportunity costs are the benefits that are
forfeited or lost from forgoing the next best
alternative use – these must be included
Equipment-Replacement Decisions
• Sometimes difficult due to amount of
information at hand that is irrelevant:
– Cost, Accumulated Depreciation, and Book
Value of existing equipment
– Any potential Gain or Loss on the transaction –
a Financial Accounting phenomenon only
• Decision Rule: Select the alternative that
will generate the highest present value
Sunk Costs Example – Replacing
a truck that cost $120,000
• A cost is sunk if
– it has already been spent or irrevocably committed
– it cannot be recovered
• Example of Sunk Cost
– TransitCo Inc buys a Semi-Truck for $120,000 cash (15 y)
– But the after 2 years Quantum Batteries are invented that use
cheap solar power, making the non electric truck obsolete
– New solar truck will cost $180K
The company now has two choices
– Option A: Go Solar
- Option B: Stay Diesel
– Loss on sale: $104,000
- No loss on sale
– Pay $180,000 for new truck - Higher operating costs
Real World Equipment Replacement
Example – Tesla Semi
• Option 1: Keep
existing diesel truck
– Startup cost: $0 (loss
on sale is not a cash
flow)
– Annual Cash outflow:
Diesel at ~$37,400 per
year
• Option 2: Tesla Semi
electric truck
– Startup cost: $180K
– Suppose we can sell
the old truck for resale
value of $80,000…
– Annual cash outflow:
lower ongoing cost
Relevant to trucking companies
considering Tesla Semi
Lecture 3 Agenda
Chapter 1: Quirks of variable and fixed costs
Chapter 1: Incremental costs
Chapter 2: What’s Job Order Costing?
Introduction to next topics
Chapters 2-3: Job Order Costing
• Job Order costing is one of the most common
implementations of costing in US businesses
• It is designed to cost customized tasks or
product batches called “jobs”
• Job order costing
– Tracks direct materials and direct labor to the jobs
– Allocates manufacturing overhead to the jobs
Key Management/Measurement Question
Chapter 2: What is the
management question? (Exh P-5)
• “How much does it cost us to manufacture
customized jobs for each of our customers?”
– Production costs are what we look at right now
• Direct materials + Direct Labor +
Manufacturing overhead (MOH)
– An MOH allocation method is needed because
some costs are shared between products
• Job order costing uses a fairly simple MOH
allocation method suitable for product portfolios of
moderate complexity
Job Order Costing - This time
• Basic Job order costing
• When do we need departmental costing?
• Cost flow and accounting entries in the job
order costing system
• The wonders of year end adjustment to
account for overhead allocation issues
• How it all fits into financial statements
– Cost of Goods Manufactured (COGM)
– Cost of Goods Sold (COGS)
• Applying job-costing to services
Job-order costing systems are
used when…
• Many different products are produced each
period.
• Products are manufactured to order.
• The unique nature of each order requires
tracing or allocating costs to each job, and
maintaining cost records for each job.
Example of a Suitable “Job”
• Batch of Diesel Jeans (page 61)
– Different styles – requiring…
• Different fabrics
• Different buttons
• Different stitching
– BUT every batch or job makes use of shared
factory costs
• Production supervision
• Rent, insurance, property taxes of the factory
Other Examples of companies that
would use job-order costing…
• Boeing (aircraft manufacturing)
• Bechtel International (large scale
construction)
• Hallmark (batches of greetings cards)
• LSG Skychefs (batches of meals for
different airlines and routes)
• Columbia Pictures (movies, pp. 75)
Reminder: What’s in DM, DL, MOH?
• Examples of DM
– Large parts in the product
– Must be economical/worthwhile to track these costs
• Examples of DL
– Assembly line labor, work shop labor
– Often they “touch” the product
• Examples of MOH
– Everything else in the manufacturing facility
– Rent, heat, light, indirect labor, indirect materials
Total Costs in Job Order Costing
• Total manufacturing costs are calculated as
TMC =
Direct costs - tracked
Direct Materials (DM)
+
Indirect costs –
Direct Labor (DL)
allocated
+
Manufacturing Overhead (MOH)
The Job Cost Card/Sheet – the
fundamental record of each job
PearCo Job Cost Sheet
Job Number A - 143
Department B3
Item Wooden cargo crate
Direct Materials
Req. No. Amount
Date Initiated 3-4-11
Date Completed
Units Completed
Direct Labor
Ticket
Hours Amount
Cost Summary
Direct Materials
Direct Labor
Manufacturing Overhead
Total Cost
Unit Product Cost
Manufacturing Overhead
Hours
Rate
Amount
Units Shipped
Date
Number Balance
Job Cost Card holds data on
direct and indirect costs
• Direct materials used – write cost on card
• Direct labor used – write on card
• MOH – allocation of MOH is added to card
based on a systematic method of “sharing
out” the overhead cost
Now, job cost cards are often computerized
e.g. Workforce scans bar codes when they
commence work on a new job (see page 64)
Quick Check
• Which of the following would have actual
costs noted on a job cost card for an auto?
(more than one answer can be correct)
A.
B.
C.
D.
Sheet metal components of the auto body
Cost of workers doing quality control
Sales commissions specifically for the car
Cost of workers assembling car
Calculating the MOH for jobs
• The total MOH must be “shared out” or
allocated between all of the jobs
• It is allocated relative to the usage of an
indicator of the overhead used
• This indicator of the overhead used is called
an allocation base
• An example of an allocation base is direct
labor hours
Using an allocation base
• All of the MOH costs for the year must be
allocated
• To help ensure this, an overhead rate
(OHR) is calculated at the start of the year:POHR =
Estimated total manufacturing
overhead cost for the coming period
Estimated total units in the
allocation base for the coming period
• P means “predetermined”
Quick Check Question ✓
• Tiger, Inc. had budgeted overhead of $1.2m and
budgeted machine hours of 300,000 in 2019.
Actual manufacturing overhead costs were
$1,210,000. Tiger, Inc. worked 290,000 machine
hours during the period. What was Tiger’s POHR
(in $ per machine hour) during 2019?
a.
b.
c.
d.
$4 per machine hour.
$4.09 per machine hour.
$4.17 per machine hour.
$8.19 per machine hour.
Who are Yost?
• Yost Precision Machining are the example
company in Chapter 2
• They are making some special order
couplings (Job 2B47) for a new customer
• Sample job to try and attract the new
business
– Done on small volume (2 units)
– They will charge the cost to the customer
– Appropriate costing demonstrates the system to
us and shows honesty to the customer
Ref: page 68
Cost of the Special Order
Couplings (Job 2B47)
• Pages 62-69 discuss the “Special Order
Couplings” job in more detail
• Page 68 shows the total costs
• Calculating the cost of the job:TMC = DM+DL+MOH
TMC = $1404 + $446 + MOH???
-To get the MOH, examine the detail of the cost card
-We see 27 hours => MOH is 27x$20 (POHR) = $540
→TMC = $1404 + $446 + $540 = $2390
How do they calculate the $540
MOH for the job (page 67)?
• They know that the job took 27 hours of work
• Then they recall the beginning of year
calculations of POHR where Yost estimated…
– Total MOH cost this year of $800,000
– Total Direct Labor Hours expected to be 40,000
– POHR = $800,000/40,000DLH = $20/DLH
• Allocation: 27 hours used x $20 rate = $540
Quick Check Question ✓
• A batch of 40 car batteries required $200 of direct
materials and 10 direct labor hours at $15 per hour.
Estimated total overhead for the year was $760,000
and estimated direct labor hours were 20,000. What
would be recorded as the cost of the batch?
a. $200.
b. $350.
c. $380.
d. $730.
Costing Approaches
• Actual Costing – allocates indirect costs
based on the actual indirect-cost rates times
the actual activity consumption
• Normal Costing – allocates indirect costs
based on the budgeted indirect-cost rates
times the actual activity consumption
• Both methods track direct costs to a cost
object the same way: by using actual directcost rates times actual consumption
Normal Costing is the Practical
System
• In practice we need to estimate total costs
(including indirect) before we know total
indirect costs for PRICING
• So we estimate how much indirect cost
there will be per direct labor hour, and use
that to estimate total cost during the year
• At the end of the year we may have to make
an adjustment if indirect cost overshoots
Lecture 3 Agenda
Chapter 1: Quirks of variable and fixed costs
Chapter 1: Incremental costs
Chapter 2: What’s Job Order Costing?
Introduction to next topics
Job Order Costing - Next time
• Basic Job order costing
• When do we need departmental costing?
• Cost flow and accounting entries in the job
order costing system
• The wonders of year end adjustment to
account for overhead allocation issues
• How it all fits into financial statements
– Cost of Goods Manufactured (COGM)
– Cost of Goods Sold (COGS)
• Applying job-costing to services
Departmental Costing and
Overhead Rates
• Machining department
– May be more automated
– Allocation base: machine hours
• Finishing department
– May be more labor intensive
– Allocation base: direct labor hours
• Allows more accuracy as the allocation
bases drive costs more closely
SUMMARY DIAGRAM
BALANCE SHEET
INCOME
STATEMENT
Inventoriable Costs (costs that can be “stored” in inventory)
Materials
purchased
DL used
MOH
applied
When
finished
COGM
When sold
COGS
DM
moved
Revenues
deduct
Cost of Goods
Sold (an expense)
Equals Gross Margin
deduct
Raw Materials
Inventory
Work in Process
Inventory
Finished Goods
Inventory
(receiving dock)
(factory floor)
(FG warehouse)
Period Costs: must be expensed immediately, we
assume no “benefit” carries over to next period
R&D costs
G&A Costs
Marketing Costs
Distribution Costs
Customer-Service Costs
Equals Operating
Income
Simple Principle of calculating raw
materials used and other flows
• What I end up with = what I start with +
what I put in – what I take out
• For any inventory account “I”
▪ I1 = I0 + Inflow – Outflow
▪ Outflow = I0 + Inflow – I1
• Example of the Raw Materials (RM)
account
▪ RM_Used = RM0 + RM_purchased – RM1