Chapter
1
Managerial Accounting &
Cost Concept
Managerial Accounting and
Financial Accounting
Managerial accounting
provides information
for managers of an
organization who
direct and control
its operations.
Irwin/McGraw-Hill
2
Financial accounting
provides information
to stockholders,
creditors and others
who are outside
the organization.
© The McGraw-Hill Companies, Inc., 2002
Work of Management
Planning
Directing and
Motivating
Controlling
Irwin/McGraw-Hill
3
© The McGraw-Hill Companies, Inc., 2002
Planning and Control Cycle
Formulating Long-and
Short-Term Plans
(Planning)
Comparing Actual
to
Planned Performance
(Controlling)
Decision
Making
Begin
Implementing
the Plans
(Directing and
Motivating)
Measuring
Performance
(Controlling)
Irwin/McGraw-Hill
4
© The McGraw-Hill Companies, Inc., 2002
Differences Between Financial and
Managerial Accounting
Financial
Accounting
Managerial
Accounting
External persons who
make financial decisions
Managers who plan for
and control an organization
Historical perspective
Future emphasis
3. Verifiability
versus relevance
Emphasis on
verifiability
Emphasis on relevance
for planning and control
4. Precision versus
timeliness
Emphasis on
precision
Emphasis on
timeliness
5. Subject
Primary focus is on
the whole organization
Focuses on segments
of an organization
6. Requirements
Must follow GAAP
and prescribed formats
Need not follow GAAP
or any prescribed format
1. Users
2. Time focus
Irwin/McGraw-Hill
5
© The McGraw-Hill Companies, Inc., 2002
Cost Classifications
Irwin/McGraw-Hill
6
© The McGraw-Hill Companies, Inc., 2002
Cost Classifications for Assigning
Costs to Cost Objects
DIRECT COST
INDIRECT COST
 A cost that can be easily and
 A cost that cannot be easily and
conveniently traced to a
specified cost object.
conveniently traced to a
specified cost object.
 Examples: direct material and
direct labor
 Example: manufacturing
overhead
 If Adidas is assigning costs to its
 a Campbell Soup factory may
various regional and national
sales offices, then the salary of
the sales manager in its Tokyo
office would be a direct cost of
that office.
produce dozens of varieties of
canned soups. The factory
manager’s salary would be an
indirect cost of a particular
variety such as chicken noodle
soup.
Irwin/McGraw-Hill
7
© The McGraw-Hill Companies, Inc., 2002
Comparing Merchandising and
Manufacturing Activities
Merchandisers . . .
Manufacturers . . .
 Buy finished goods.
 Buy raw materials.
 Sell finished goods.
 Produce and sell
finished goods.
MegaLoMart
Irwin/McGraw-Hill
8
© The McGraw-Hill Companies, Inc., 2002
Cost Classifications for
Manufacturing Companies
Direct
Materials
Direct
Labor
Manufacturing
Overhead
The Product
Irwin/McGraw-Hill
9
© The McGraw-Hill Companies, Inc., 2002
Direct Materials
Those materials that become an integral part
of the product and that can be conveniently
traced directly to it.
Example: An Airbag installed in an automobile
Irwin/McGraw-Hill
10
© The McGraw-Hill Companies, Inc., 2002
Direct Labor
Those labor costs that can be easily traced to
individual units of product.
Example: Wages paid to automobile assembly workers
Irwin/McGraw-Hill
11
© The McGraw-Hill Companies, Inc., 2002
Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect labor and indirect materials
Wages paid to employees
who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.
Irwin/McGraw-Hill
12
Materials used to support
the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.
© The McGraw-Hill Companies, Inc., 2002
Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct
Material
Direct
Labor
Prime
Cost
Irwin/McGraw-Hill
Manufacturing
Overhead
Conversion
Cost
13
© The McGraw-Hill Companies, Inc., 2002
Nonmanufacturing Costs
Marketing and selling costs . . .
 Costs necessary to get the order and deliver the
product.
Administrative costs . . .
 All executive, organizational, and clerical costs.
Irwin/McGraw-Hill
14
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
15
© The McGraw-Hill Companies, Inc., 2002
Cost Classifications for Preparing
Financial Statements
Product costs include
direct materials, direct
labor, and manufacturing
overhead.
Inventory
Period costs are not
included in product costs.
Such as advertising, rental
cost, etc. They are
expensed on the income
statement.
Cost of Good Sold
Expense
Income
Statement
Income
Statement
Sale
Balance
Sheet
Irwin/McGraw-Hill
17
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
18
© The McGraw-Hill Companies, Inc., 2002
Balance Sheet
Merchandiser
Manufacturer
Current assets
Current Assets
 Cash
 Cash
 Receivables
 Receivables
 Prepaid expenses
 Prepaid Expenses
 Merchandise inventory
 Inventories
Raw Materials
Work in Process
Finished Goods
Irwin/McGraw-Hill
20
© The McGraw-Hill Companies, Inc., 2002
Balance Sheet
Merchandiser
Manufacturer
Current assets
Current Assets
 Cash
 Cash
 Receivables

Receivables
Materials
waiting to
 Prepaid expenses
be processed.
 Prepaid
Expenses
 Merchandise
inventory
Partially complete
 Inventories
Raw Materials
Work in Process
Finished Goods
products – some
material, labor, or
overhead has been
added.
Completed products
awaiting sale.
Irwin/McGraw-Hill
21
© The McGraw-Hill Companies, Inc., 2002
The Income Statement
Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for merchandisers.
Merchandising Company
Cost of goods sold:
Beg. merchandise
inventory
$ 14,200
+ Purchases
234,150
Goods available
for sale
$ 248,350
- Ending
merchandise
inventory
(12,100)
= Cost of goods
sold
$ 236,250
Irwin/McGraw-Hill
22
Manufacturing Company
Cost of goods sold:
Beg. finished
goods inv.
+ Cost of goods
manufactured
Goods available
for sale
- Ending
finished goods
inventory
= Cost of goods
sold
$ 14,200
234,150
$248,350
(12,100)
$236,250
© The McGraw-Hill Companies, Inc., 2002
Manufacturing Cost Flows
Costs
Balance Sheet
Inventories
Material Purchases
Raw Materials
Direct Labor
Work in
Process
Manufacturing
Overhead
Selling and
Administrative
Irwin/McGraw-Hill
Finished
Goods
Period Costs
23
Income
Statement
Expenses
Cost of
Goods
Sold
Selling and
Administrative
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
24
© The McGraw-Hill Companies, Inc., 2002
Inventory Flows
Beginning
balance
$$
Available
$$$$$
Irwin/McGraw-Hill
+
Additions
$$$
_ Withdrawals
$$$
26
=
Available
$$$$$
=
Ending
balance
$$
© The McGraw-Hill Companies, Inc., 2002
Quick Check 
If your bank balance at the beginning of the
month was $1,000, you deposited $100 during
the month, and withdrew $300 during the
month, what would be the balance at the end of
the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.
Irwin/McGraw-Hill
27
© The McGraw-Hill Companies, Inc., 2002
Product Costs - A Closer Look
Raw Materials
Manufacturing
Costs
Work
In Process
Beginning raw
materials inventory
Beginning inventory
is the inventory
carried over from
the prior period.
Irwin/McGraw-Hill
29
© The McGraw-Hill Companies, Inc., 2002
Product Costs - A Closer Look
Raw Materials
Beginning raw
materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
Irwin/McGraw-Hill
Manufacturing
Costs
Work
In Process
Direct materials
As items are removed from raw
materials inventory and placed into
the production process, they are
called direct materials.
30
© The McGraw-Hill Companies, Inc., 2002
Product Costs - A Closer Look
Raw Materials
Beginning raw
materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
Irwin/McGraw-Hill
Manufacturing
Costs
Work
In Process
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs
31
© The McGraw-Hill Companies, Inc., 2002
Product Costs - A Closer Look
Raw Materials
Beginning raw
materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
Irwin/McGraw-Hill
Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs
32
Work
In Process
Conversion
costs are costs
incurred to
convert the
direct material
into a finished
product.
© The McGraw-Hill Companies, Inc., 2002
Product Costs - A Closer Look
Raw Materials
Beginning raw
materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
Irwin/McGraw-Hill
Manufacturing
Costs
Work
In Process
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs
Beginning work in
process inventory
+ Total manufacturing
costs
= Total work in
process for the
period
All manufacturing costs incurred
during the period are added to the
beginning balance of work in
process.
33
© The McGraw-Hill Companies, Inc., 2002
Product Costs - A Closer Look
Raw Materials
Beginning raw
materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
Manufacturing
Costs
Work
In Process
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs
Beginning work in
process inventory
+ Total manufacturing
costs
= Total work in
process for the
period
– Ending work in
process inventory
= Cost of goods
manufactured.
Costs associated with the goods that
are completed during the period are
transferred to finished goods
inventory.
Irwin/McGraw-Hill
34
© The McGraw-Hill Companies, Inc., 2002
Product Costs - A Closer Look
Work
In Process
Finished Goods
Beginning work in
process inventory
+ Manufacturing costs
for the period
= Total work in process
for the period
– Ending work in
process inventory
= Cost of goods
manufactured
Irwin/McGraw-Hill
35
Beginning finished
goods inventory
+ Cost of goods
manufactured
= Cost of goods
available for sale
- Ending finished
goods inventory
Cost of goods
sold
© The McGraw-Hill Companies, Inc., 2002
Quick Check 
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used?
A.
$276,000
B.
$272,000
C.
$280,000
D.
$ 2,000
Irwin/McGraw-Hill
36
© The McGraw-Hill Companies, Inc., 2002
Quick Check 
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A.
$555,000
B.
$835,000
C.
$655,000
D.
Cannot be determined.
Irwin/McGraw-Hill
38
© The McGraw-Hill Companies, Inc., 2002
Quick Check 
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A.
$1,160,000
B.
$ 910,000
C.
$ 760,000
D.
Cannot be determined.
Irwin/McGraw-Hill
40
© The McGraw-Hill Companies, Inc., 2002
Quick Check 
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
Irwin/McGraw-Hill
42
© The McGraw-Hill Companies, Inc., 2002
To Be Continued …
Cost Classifications for Predicting
Cost Behavior
How a cost will react to
changes in the level of
business activity.
 Variable costs change
when activity changes.
 Fixed costs remain
unchanged when activity
changes.
 Mixed costs contains both
variable and fixed cost
elements.
Irwin/McGraw-Hill
45
© The McGraw-Hill Companies, Inc., 2002
Variable Cost
A variable cost varies, in total, in direct
proportion to changes in the level of
activity.
For a cost to be variable, it must be
variable with respect to activity base.
Irwin/McGraw-Hill
46
© The McGraw-Hill Companies, Inc., 2002
Variable Cost
Example:
Consider Nooksack Expeditions, a small company that provides daylong
whitewater rafting excursions on rivers in the North Cascade Mountains.
The company provides all of the necessary equipment and experienced
guides, and it serves gourmet meals to its guests. The meals are
purchased from a caterer for $30 a person for a daylong excursion. The
behavior of this variable cost, on both a per unit and a total basis, is
shown below:
While total variable costs change as the activity level changes, it is important
to note that a variable cost is constant if expressed on a per unit basis.
For example, the per unit cost of the meals remains constant at $30 even
though the total cost of the meals increases and decreases with activity.
Irwin/McGraw-Hill
47
© The McGraw-Hill Companies, Inc., 2002
Variable Cost
Example:
The graph on the left-hand side of Exhibit 1–3 illustrates that the total
variable cost rises and falls as the activity level rises and falls. At an
activity level of 250 guests, the total meal cost is $7,500. At an activity
level of 1,000 guests, the total meal cost rises to $30,000.
Irwin/McGraw-Hill
48
© The McGraw-Hill Companies, Inc., 2002
Fixed Cost
A fixed cost is a cost that remains constant,
in total, regardless of changes in the level
of activity.
Irwin/McGraw-Hill
49
© The McGraw-Hill Companies, Inc., 2002
Fixed Cost
Example:
Assume the company rents a building for $500 per month to store its
equipment. The total amount of rent paid is the same regardless of the
number of guests the company takes on its expeditions during any given
month. Because total fixed costs remain constant for large variations in
the level of activity, the average fixed cost per unit becomes progressively
smaller as the level of activity increases. If Nooksack Expeditions has
only 250 guests in a month, the $500 fixed rental cost would amount to an
average of $2 per guest. If there are 1,000 guests, the fixed rental cost
would average only 50 cents per guest. The table below illustrates this
aspect of the behavior of fixed costs:
Irwin/McGraw-Hill
50
© The McGraw-Hill Companies, Inc., 2002
Fixed Cost
Example:
The concept of a fixed cost is shown graphically on the right-hand side of
Exhibit 1–3.
Irwin/McGraw-Hill
51
© The McGraw-Hill Companies, Inc., 2002
Cost Classifications for Predicting
Cost Behavior
Behavior of Cost (within the relevant range)
Cost
In Total
Per Unit
Variable
Total variable cost changes
as activity level changes.
Variable cost per unit remains
the same over wide ranges
of activity.
Fixed
Total fixed cost remains
the same even when the
activity level changes.
Fixed cost per unit goes
down as activity level goes up.
Irwin/McGraw-Hill
52
© The McGraw-Hill Companies, Inc., 2002
Mixed Cost
Mixed costs are also known
as semi variable costs.
Irwin/McGraw-Hill
53
© The McGraw-Hill Companies, Inc., 2002
Mixed Cost
Example:
The company incurs a mixed cost called fees paid to the state. It includes a license fee of
$25,000 per year plus $3 per rafting party paid to the state’s Department of Natural
Resources. If the company runs 1,000 rafting parties this year, then the total fees paid
to the state would be $28,000, made up of $25,000 in fixed cost plus $3,000 in variable
cost.
Even if Nooksack fails to attract any customers, the company will still have to pay the
license fee of $25,000. This is why the cost line in Exhibit 1–6 intersects the vertical
cost axis at the $25,000 point. For each rafting party the company organizes, the total
cost of the state fees will increase by $3. Therefore, the total cost line slopes upward as
the variable cost of $3 per party is added to the fixed cost of $25,000 per year.
Irwin/McGraw-Hill
54
© The McGraw-Hill Companies, Inc., 2002
Mixed Cost
Example:
Because the mixed cost in Exhibit 1–6 is represented by a straight line, the following
equation for a straight line can be used to express the relationship between a mixed
cost and the level of activity:
Because the variable cost per unit equals the slope of the straight line, the steeper the
slope, the higher the variable cost per unit. In the case of the state fees paid by
Nooksack Expeditions, the equation is written as follows:
Irwin/McGraw-Hill
55
© The McGraw-Hill Companies, Inc., 2002
Mixed Cost
Example:
This equation makes it easy to calculate the total mixed cost for any activity level within the
relevant range. For example, suppose that the company expects to organize 800 rafting
parties in the next year. The total state fees would be calculated as follows:
Irwin/McGraw-Hill
56
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
57
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
59
© The McGraw-Hill Companies, Inc., 2002
Cost Classifications for Decision
Making
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:
$2,000 – $1,500 = $500
Differential cost is:
$300
Irwin/McGraw-Hill
61
© The McGraw-Hill Companies, Inc., 2002
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 pizza you ate last night relevant
in this decision? In other words, should the cost
of the pizza affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the pizza is relevant.
B. No, the cost of the pizza is not relevant.
Irwin/McGraw-Hill
62
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
64
© The McGraw-Hill Companies, Inc., 2002
Note
 Every decision involves a choice from
among at least two alternatives.
 Only those costs and benefits that differ
between alternatives (i.E., Differential
costs and benefits) are relevant in a
decision. All other costs and benefits can
and should be ignored.
Irwin/McGraw-Hill
66
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
67
© The McGraw-Hill Companies, Inc., 2002
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 depreciation on your car relevant in this
decision?
A. Yes, the depreciation is relevant.
B. No, the depreciation is not relevant.
Irwin/McGraw-Hill
69
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
71
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
72
© The McGraw-Hill Companies, Inc., 2002
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.
Irwin/McGraw-Hill
73
© The McGraw-Hill Companies, Inc., 2002