TM 2-1
AGENDA: MANAGERIAL ACCOUNTING
AND COST CONCEPTS
A.
The work of management.
B.
Management accounting contrasted with financial accounting.
C.
Cost classifications for:
1. Financial statement preparation.
2. Predicting cost behavior.
3. Assigning costs to cost objects.
4. Making decisions
D. Accounting for labor costs.
E.
Cost of Quality.
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TM 2-2
THE PLANNING AND CONTROL CYCLE
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TM 2-3
MANAGERIAL AND FINANCIAL ACCOUNTING CONTRASTED
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TM 2-4
AN OVERVIEW OF COST CLASSIFICATIONS IN CHAPTER 2
Purpose of classification
Cost classifications
Preparing an income
statement and balance
sheet
• Product costs
• Direct materials
• Direct labor
• Manufacturing overhead
• Period costs (nonmanufacturing costs)
• Selling costs
• Administrative costs
Predicting changes in cost
• Variable costs
due to changes in activity • Fixed costs
Assigning costs
• Direct costs
• Indirect costs
Making decisions
• Differential costs
• Sunk costs
• Opportunity costs
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TM 2-5
COST CLASSIFICATIONS IN MANUFACTURING COMPANIES
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TM 2-6
COST FLOWS IN A MANUFACTURING COMPANY
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TM 2-7
COST FLOWS EXAMPLE
EXAMPLE: Ryarder Company incurred the following costs last month:
Purchases of raw materials ..........
Direct labor .................................
Manufacturing overhead ..............
$200,000
$270,000
$420,000
But:
• Some of the goods sold this month were produced in previous months.
• Some of the costs listed above were incurred to make goods that were
not sold this month.
Therefore:
• Cost of goods sold does not equal the sum of the above costs.
• We need to determine the values of the various inventories.
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TM 2-8
COST FLOWS EXAMPLE (continued)
Additional data for Ryarder Company:
Raw materials inventory:
Beginning raw materials inventory .............
Purchases of raw materials ........................
Ending raw materials inventory ..................
Raw materials used in production ..............
$10,000
$200,000
$30,000
?
Work in process inventory:
Beginning work in process inventory ..........
Total manufacturing costs .........................
Ending work in process inventory...............
Cost of goods manufactured (i.e., finished)
$40,000
?
$60,000
?
Finished goods inventory:
Beginning finished goods inventory ............
Cost of goods manufactured (i.e., finished)
Ending finished goods inventory ................
Cost of goods sold ....................................
$130,000
?
$80,000
?
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TM 2-9
INVENTORY FLOWS
Basic Equation for Inventory Accounts:
Beginning + Additions = Ending + Withdrawals
balance
to inventory
balance
from inventory
or
Withdrawals = Beginning + Additions - Ending
from inventory
balance
to inventory balance
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TM 2-10
COST FLOWS EXAMPLE (continued)
Computation of raw materials used in production
Beginning raw materials inventory ................ $ 10,000
+ Purchases of raw materials ........................... 200,000
– Ending raw materials inventory .....................
30,000
= Raw materials used in production ................. $180,000
Computation of total manufacturing cost
Raw materials used in production ................. $180,000
+ Direct labor .................................................
270,000
+ Manufacturing overhead ...............................
420,000
= Total manufacturing cost .............................. $870,000
Computation of cost of goods manufactured
Beginning work in process inventory ............. $ 40,000
+ Total manufacturing cost ..............................
870,000
– Ending work in process inventory..................
60,000
= Cost of goods manufactured (i.e., finished) ... $850,000
Computation of cost of goods sold
Beginning finished goods inventory ..............
+ Cost of goods manufactured (i.e., finished) ..
– Ending finished goods inventory ..................
= Cost of goods sold ......................................
$130,000
850,000
80,000
$900,000
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TM 2-11
SCHEDULE OF COST OF GOODS MANUFACTURED
Ryarder Company
Schedule of Cost of Goods Manufactured
Direct materials:
Beginning raw materials inventory ..........
Add: Purchases of raw materials ............
Raw materials available for use ..............
Deduct: Ending raw materials inventory ..
Raw materials used in production ...........
Direct labor .............................................
Manufacturing overhead ...........................
Total manufacturing cost ..........................
Add: Beginning work in process inventory .
Deduct: Ending work in process inventory .
Cost of goods manufactured .....................
Cost of Goods Sold
Beginning finished goods inventory ...........
Add: Cost of goods manufactured .............
Goods available for sale ...........................
Deduct: Ending finished goods inventory ...
Cost of goods sold ...................................
$ 10,000
200,000
210,000
30,000
$180,000
270,000
$420,000
870,000
40,000
910,000
60,000
$850,000
$130,000
850,000
980,000
80,000
$900,000
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TM 2-12
COST CLASSIFICATIONS TO PREDICT COST BEHAVIOR
To predict how costs react to changes in activity, costs are often classified
as variable or fixed.
VARIABLE COSTS
Variable cost behavior can be summarized as follows:
In Total
Variable Cost Behavior
Total variable cost increases
and decreases in proportion
to changes in activity.
Per Unit
Variable cost per
unit is constant.
EXAMPLE: A company manufactures microwave ovens. Each oven requires
a timing device that costs $30. The cost per unit and the total cost of the
timing device at various levels of activity (i.e., number of ovens produced)
would be:
Cost per
Timing
Device
$30
$30
$30
$30
Number of
Ovens
Produced
1
10
100
200
Total Variable
Cost—Timing
Devices
$30
$300
$3,000
$6,000
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TM 2-13
FIXED COSTS
Fixed cost behavior can be summarized as follows:
In Total
Fixed Cost Behavior
Total fixed cost is not affected
by changes in activity (i.e., total
fixed cost remains constant even
if activity changes).
Per Unit
Fixed cost per unit decreases
as the activity level rises and
increases as the activity level
falls.
EXAMPLE: Assume again that a company manufactures microwave ovens.
The company pays $9,000 per month to rent its factory building. The total
cost and the cost per unit of rent at various levels of activity would be:
Rent Cost
per Month
$9,000
$9,000
$9,000
$9,000
Number of
Ovens
Produced
1
10
100
200
Rent Cost
per Oven
$9,000
$900
$90
$45
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TM 2-14
A GRAPHIC VIEW OF COST BEHAVIOR
$6,000
Total Variable Cost
Total Fixed Cost
$9,000
$3,000
0
100
200
Microwaves produced
0
100
200
Microwaves produced
RELEVANT RANGE
If activity changes enough, fixed costs may change. For example, if
microwave production were doubled, another factory building might have
to be rented.
The relevant range is the range of activity within which the assumptions
that have been made about variable and fixed costs are valid. For
example, the relevant range within which total fixed factory rent is $9,000
per month might be 1 to 200 microwaves produced per month.
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TM 2-15
COST CLASSIFICATIONS FOR ASSIGNING COSTS TO COST
OBJECTS
COST OBJECT
A cost object is anything for which cost data are desired.
Examples of cost objects:
• Products
• Customers
• Departments
• Jobs
DIRECT COSTS
A direct cost is a cost that can be easily and conveniently traced to a
particular cost object.
Examples of direct costs:
• The direct costs of a Ford SUV would include the cost of the steering
wheel purchased by Ford from a supplier, the costs of direct labor
workers, the costs of the tires, and so on.
• The direct costs of a hospital’s radiology department would include Xray film used in the department, the salaries of radiologists, and the
costs of radiology lab equipment.
INDIRECT COSTS
An indirect cost is a cost that cannot be easily and conveniently traced
to a particular cost object.
Examples of indirect costs:
• Manufacturing overhead, such as the factory managers’ salary at a
multi-product plant, is an indirect cost of any one product.
• General hospital administration costs are indirect costs of the radiology
lab.
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TM 2-16
COST CLASSIFICATIONS FOR DECISION-MAKING
DIFFERENTIAL COST
Every decision involves choosing from among at least two alternatives. Any
cost that differs between alternatives is a differential cost. Only the
differential costs are relevant in making a decision.
EXAMPLE: Bill is currently employed as a lifeguard, but he has been
offered a job in an auto service center in the same town. When comparing
the two jobs, the differential revenues and costs are:
Monthly salary ....................
Monthly expenses:
Commuting ......................
Meals ...............................
Apartment rent .................
Uniform rental ..................
Sunscreen ........................
Total monthly expenses .......
Net monthly income ............
$1,200
Auto
Service
Center
$1,500
Differential
costs and
revenues
30
150
450
0
10
640
$ 560
90
150
450
50
0
740
$ 760
60
0
0
50
(10)
100
$200
Lifeguard
$300
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TM 2-17
OPPORTUNITY COST
An opportunity cost is the potential benefit given up when selecting one
course of action over another.
EXAMPLE: Linda has a job in the campus bookstore and is paid $65 per
day. One of her friends is getting married and Linda would like to attend
the wedding, but she would have to miss a day of work. If she attends the
wedding, the $65 in lost wages will be an opportunity cost of attending the
wedding.
EXAMPLE: The reception for the wedding mentioned above will be held in
the ballroom at the Lexington Club. The manager of the Lexington Club
had to decide between accepting the booking for the wedding reception or
accepting a booking for a corporate seminar. The hall could have been
rented to the corporation for $600. The lost rental revenue of $600 is an
opportunity cost of accepting the reservation for the wedding.
SUNK COST
A sunk cost is a cost that has already been incurred and that cannot be
changed by any decision made now or in the future. Sunk costs are
irrelevant and should be ignored in decisions.
EXAMPLE: Linda has already purchased a ticket to a rock concert for $35.
If she goes to the wedding, she will be unable to attend the concert. The
$35 is a sunk cost that she should ignore when deciding whether or not to
attend the wedding. [However, any amount she can get by reselling the
ticket is NOT a sunk cost. And while she should ignore the $35 sunk cost,
she should not ignore the enjoyment she would get if she were to attend
the concert.]
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TM 2-18
ACCOUNTING FOR LABOR COSTS (Appendix 2A)
Labor costs can be categorized as follows:
Direct labor
(Discussed earlier)
Indirect labor
(part of manufacturing
overhead)
Janitors
Supervisors
Materials handlers
Engineers
Night security guards
Maintenance workers
Other labor costs
Idle time
Overtime premium
Labor fringe
benefits
IDLE TIME
Idle time represents the wages of direct labor workers who are idle due
to machine breakdowns, material shortages, power failures, and the like.
The cost of idle time is often added to manufacturing overhead.
EXAMPLE: An assembly line worker is idle for 2 hours during the week due
to a power failure. If the worker is paid $15 per hour and works a normal
40 hour week, labor cost would be allocated as follows between direct
labor and manufacturing overhead:
Direct labor cost ($15 per hour × 38 hours) ................
Manufacturing overhead cost ($15 per hour × 2 hours)
Total cost for the week ...............................................
$570
30
$600
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TM 2-19
OVERTIME PREMIUM
Any overtime premium paid to factory workers (direct as well as indirect
labor) is usually considered to be part of manufacturing overhead.
EXAMPLE: Assume again that an assembly line worker is paid $15 per
hour. The worker is paid time and a half for overtime (time in excess of 40
hours per week). During a given week this employee works 46 hours and
has no idle time. Labor cost would be allocated as follows:
Direct labor cost ($15 per hour × 46 hours) ......................
Manufacturing overhead cost ($7.50 per hour × 6 hours) ...
Total cost for the week .....................................................
$690
45
$735
LABOR FRINGE BENEFITS
Labor fringe benefits are made up of employment related costs paid by the
employer. These costs are handled in two different ways by companies:
1.
Many companies treat all such costs as indirect labor and add them to
manufacturing overhead.
2.
Other companies treat that portion of fringe benefits that relates to
direct labor as additional direct labor cost.
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TM 2-20
QUALITY COSTS (Appendix 2B)
• The costs of correcting defective units before they reach customers are
called internal failure costs. Examples:
• Scrapped units.
• Rework of defective units.
• Costs that are incurred by releasing defective units to customers are
called external failure costs. Examples:
• Costs of fixing products under warranty.
• Loss of sales due to a tarnished reputation.
• The costs of internal and external failures can be avoided by:
• Preventing defects.
• Finding defective units before they are released.
The costs associated with these activities are called prevention costs and
appraisal costs, respectively.
• Generally, prevention is the best policy. It is usually far easier and less
expensive to prevent defects than to fix them.
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TM 2-21
EXAMPLES OF QUALITY COSTS
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TM 2-22
TRADING-OFF QUALITY COSTS
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TM 2-23
QUALITY COST REPORTS
• Quality cost reports summarize prevention costs, appraisal costs, internal
failure costs, and external failure costs that would otherwise be hidden
in general overhead.
• Managers are often surprised by how much defects cost.
• The report helps identify where the biggest quality problems lie.
• The report helps managers assess how resources should be
distributed. If internal and external failure costs are high relative to
prevention and appraisal costs, more should probably be spent on
prevention and appraisal.
• Because quality cost reports are largely an attention-directing device,
the costs do not have to be precise.
• Unfortunately, the cost of lost sales due to external failures is usually
excluded from the reports due to measurement difficulties.
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TM 2-24
SAMPLE QUALITY COST REPORT
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