Management Accounting
2010
Second semester
Takayuki Asada
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Chapter2
Cost Management Concepts and Cost Behavior
After reading this chapter, you will be able to:
Explain why the appropriate way to calculate a cost depends on
how the cost will be used
Understand and be able to exploit the difference between direct
and indirect costs
Recognize different cost behavior patterns and use that
knowledge to predict costs and profits with different sales
levels
Understand why management accountants and financial
accountants use different approaches to classifying costs
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Show why the concepts of opprtunity cost is used in shortrun decisions making and how opportunity cost related to
conventional accounting costs
Explain the notions of long-run and short-run costs and how
these different costs are used in decision making
Explain the modern approach of cost classifications based on
activity levels
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Short case
Lynn’s landscaping Services
1)Her lanscaping business was in trouble about profit because it is to be
declining.
2)Lynn was perplexed about the decline in profit.
3)Lynn has two options for charging the price,one is to use prevailing market
price and also to use the monoply-like price which means the price she can
charge.
4)Most conventional landscapeing services were competitive and other services
are related with landscape design and planting.
5)There are two types of cost behavior,one to be variable and other to be fixed.
6)There are three kinds of fixed cost,such as salaries and eqipment costs.
7)Lynn knows that equipment deteriorates with use,so she figures that
equipment costs should be allocated in propotion to revenue,which is a
measure of use.
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Exhibit 2.1 Lynn’s Landscaping Services
Product Line Income Statement
Lawn Mowing
Revenue
230,000
Variable costs 125,000
Fixed costs
Proift
Layout Design
Other Maintenance
175,000
56,000
250,000
145,000
105,343
80,153
114,504
-343
38,847
-9,504
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2 What does cost mean?
The most common definition of cost is the monetary value of goods
and services expended to obtain current or future benefits.
Different costs for different purposes. This suggest that there is no
universal way to compute the cost of something.
Management accountants define and compute costs that reflected
identified decision making needs.
A useful way to consider the different cost organing systems is whether
The cost is needed for
external(shareholders,creditors ,gorvernment ,employees) or internal
(management) decision making.
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3 How the use of product cost information
defines its focus and form
1)Financial accoutants and management accountants define and
think about cost very differently,particulary product costs.
2)Using product cost information outside the organization
Since no one knows how the investors,etc. use the costs
numbers in financial statements,generally accepted
accoutning principles that specify the focus,content and form
of financial statements focus on methods for computing costs
rather than how they might be best caluculated to support a
given decision.
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Expenditures,Costs and Expenses
Expenses are the costs of assets that the financial accoutants deems have
been used up when goods or services are sold.
Product Costs
for manufacturing firms,financial accoutants include only manufacturing
costs in the cost they report for product inventory,and threfore,as the
expense they report for the goods sold.
insummary,for a manufacturing firms,product cost reported on the
balance sheet
include only manufacturing costs ad almost always reflected historical
costs.
Using Product Cost Information inside the organization
two broad categories which mean Planning and evaluation
1)Selling price based on cost as a reference point
2)budgeting use
3)planning and control use
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Understanding Cost Behavior to Predict Costs
understanding cost behavior allows the management
accountants to develop estimates of product costs and to
predict costs for various levels of production activity.
you can understand the different behavior of cost when you
know the notion of flexible resources and capacity related
resouces. The cost of flexible resourses are called variable
costs.
Capacity-related resources are acquired and paid for in advance
of when the work is done. The costs associated with
capacity-related resources are called fixed costs.
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Understanding Cost Behavior to cost Products
Now we will turn to consider cost concepts that management
accountants use when they compute product costs.
Direct cost
the cost of a resource or activity that is acquired for or used by a
single cost object
Indirect cost
the cost of a resource that is used by more than one cost object.
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Using Cost information to predict costs and profits
Cost-Volume-Proft Analysis is a procedure for combining information about variable and fixed costs with
revenue information for different levels of volume.
Profit=revenue- costs (2.1)
Profit = Revenue-variable costs – fixed costs (2.2)
Profit=(units sold × revenue per unit) – (units sold × variable cost per unit) – Fixed costs (2.3)
Profit = (unit sold × (revenue per unit – variable cost per unit) ) – fixed costs (2.4)
Profit = (units sold × Contribution margin per unit ) –fixed costs (2.5)
Units required to earn a target profit = (target profit + fixed cost) / contribution margin per unit
(2.6)
Breakeven unit sales = Fixed costs / cpntribution margin per unit
(2.7)
units required × revenue per unit = (target profit + fixed cost) × revenue per unit / contribution
margin per unit
(2.8)
Revenue required = (target profit + fixed cost ) / contribution margin ratio
(2.10)
Breakeven sales revenue =
(2.11)
Fixed cost
/
contribution margin ratio
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The CVP Chart:
Executives ,analysts,and regulators track average yield and load
factor for the industry and each airline very varefully since small
changes in the load factor have large effects on profits(since fixed
costs make up most of the total costs ,the total cost vurve has a
small slope) and since most airlines operate near their breakeven
load factor as shown in the practice box(p.40).
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Extending CVP analysis for multiproduct organizations
Lynn’s Landscaping Services,Lynn would construct an average product by
weighting each of her company’s three real products-lawn mowing,layout
design, and other maintenance-by their respective proportions in the
estimated product mix.
Exhibit 2-6
Lawn Mowing
Layout Design
unit total
unit
Total
Units sold 4600
350
Revenues 50,000 230,000
500
175,000
Variable
costs
27.17 125,000
160
56,000
Fixed Costs
105,343
80,153
Profit
-343
38,847
Other maintenance
Unit
Total
1250
200
250,000
116
145,000
114,504
-9,504
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Exhibit 2-7 Lynn’s Landscapeing Services:Composite Product
Calculation
Lawn Moving
unit
%Total
Unit Sold 4,600 74.193548%
unit
Revenue 50.0
Variable
costs
27.17
Contribution
Margin
Layout Design
Other Maintenance Total
unit
%Total
Unit
%total
350 5.645161% 1,250 20.161290% 6200
weight
unit
weight
unit
weight
total all
37.10
500.00
28.23
200.00
40.32
105.65
20.16
160.00
9.03
116.00
23.39
52.58
53.06
Noting that the total fixed costs at Lynn’s Landscaping is 300,000(105,343+80,153+
114,504) ,use the breakeven formula (equation 2.7) to compute the breakeven level of
sales for this composite product:
Breakeven = Fixed cost / contribution margin per unit = 300,000/53.06 (2.15)
unit sales
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Exhibit 2-9 summarises these calculations and
verifies that this mix and level of sales indeed
provides a breakeven level of profits for Lynn’s
Landscaping Services.
To summarize ,CVP analysis provided decisions
makers with a handy ,flexible and convenient
way to model the relationship between
volume and profits.
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Using Cost Information to develop Product Costs
We are faced with the problems of how to incorporate fixed
costs into a product cost.
1)A widely used approach is to divide fixed costs by the number
of units actually produced. This has the nice effect of including
all the fixed costs in the product costs,but it has the
unfortunate effect of increasing the computed
cost of a product as demand goes down.
2)An alternative approach to including fixed costs in product
costs is to divide the fixed cost by the practical level of
capacity provided to get a cost per unit of capacity.
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Do Different Costs for different Purpose cause costing chaos?
One challenge of working with costs ,however, is that they are
used in many different contexts.
If the question were rephrased as “I promised to pay John’s
admission to the movie he attended last Thursday.What was
the cost?” all ambiguity is resolved,and a specific and relevant
cost can be computed. Note that conventional accounting for
external reporting avoids all these issues because it is
understood that reported cost will be the historical cost for a
particular transaction that has already occurred.
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4.How Organization Create Costs
:An Example
1)Starting up
2)Early growth
3)Reaching the boundaries of existing capacity
4)Expanding the product line and acquring more capacity
resources
5)Redefining the business
5)Continued growth
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5. Cost Structure Today
In early 1900s,when many business first installed formal cost
systemss,directlabour represented a large proportion of the total
manufacturing costs.
In today’s industrial environment,direct labour is often only a small
proportion of manufacturing costs, The big change in cost structures of
manufacturing entities today has been the much higher share of total
costs represented by fixed costs.
1)Type of production Activities
the following hierarchy,developed for manufacturing operations,give a
broader framework for classifying an activity and its associated costs.
(1)unit related ,(2)batch related, (3)product sustaing, (4)customer sustaing,
(5)business sustaining
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2)Unit-related activities
3)Batch-related activities
4)Product-sustaining activities
5)Customer-sustainning activities
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6)Channel-sustaining activities
7)Business-sustaining activities
8)Other support activities
9)Using the cost hierarchy
The cost hierarchy developed in this section is a model of cost
behavior that can be used in two ways,to predict costs and to
develop the costs.
10)Understanding the underlying behavior of costs
There are short case for explaining behavior of costs.
11)Nonmanufacturing costs as product costs
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6.Evaluating Profit Performance at Lynn’s Landscaping
Services
Exhibit 2-23 Lynn’s Landscaping Sevices :product-line income statement
Lawn Moving Layout Design
Other maintenance
Total
Revenue
Direct costs
Margin
230,000
125,000
105,000
Cost of
used capacity
Own equipment 24,000
Trucks
10,000
Cost of unused
own capacity
6,000
Unit profit
65,000
Cost of unused
shared capacity
Business-sustaining costs
Organization profit
175,000
56,000
119,000
250,000
145,000
105,000
655,000
326,000
329,000
120,000
10,000
50,000
10,000
194,000
30,000
0
-11,000
20,000
25,000
26,000
79,000
10,000
40,000
29,000
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Summary
This chapter introduced the important idea of “Different costs
for different purposes”. This idea means that there is no one
single best way to compute cost.
This chapter discussed the ideas of short-run and long-run costs .
This chapter turned to consider how unit and batch-related and
product-,customer-,and business sustaining activities related
can create organizational costs and provide an important
introduction to cost behavior that modifies and extends the
notions of variable and fixed costs.
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