ACCT 2302
Fundamentals of Accounting II
Spring 2011
Lecture 2
Professor Jeff Yu
Review: what do managers do and how MA can help
Formulating long-and
short-term plans
Begin
(Planning)
Comparing actual to
planned performance
(Controlling)
Decision
Making
Implementing plans
(Directing and
Motivating)
Measuring performance
(Controlling)
MA provides information that help managers make decisions
throughout the planning and control cycle.
Review: Managerial vs. Financial Accounting
Financial
Accounting
Users
Time Focus
Emphasis
Verifiability and
Precision
Subject
The whole
Organization
Requirement
Follow GAAP
Managerial
Accounting
Chapter 2: Today’s Agenda
Introduce cost terms, concepts and classifications
I organize our discussions according to the three major
course themes:
How costs behave?
How accounting system reports costs?
Economic costs vs. Accounting costs
How costs behave?
Cost is a sacrifice; In accounting, a measurable cost is
typically the relinquishment of a measurable asset or
the creation of a measurable liability.
Cost Behavior: how a cost will react to a change in
activity level.
Cost Driver: The activity causing a cost to change. e.g.,
units produced, units sold, hours worked, etc.
Total Variable Cost
Total cost of
wheels
Consider the Rollerblade manufacturer: Each rollerblade produced requires
one set of wheels. If rollerblade production increases 10%, how will that
affect the total cost of wheels required for production?
Rollerblades produced
Total Fixed Cost
Total cost of
factory rental
Suppose the Rollerblade manufacturer rents a factory in which to produce
the rollerblades. How will the monthly factory rental cost change as the
number of rollerblades produced increases?
Rollerblades produced
Variable Cost Per Unit
Pairs of
Rollerblades
produced
1
10
400
500
Per unit
wheel cost
$5
$5
$5
$5
Total wheel
cost
$5
$50
$2,000
$2,500
Per unit wheel cost
Consider again the Rollerblade manufacturer: If rollerblade production
increases 10%, how much will the cost per unit cost of wheels change?
Rollerblades
produced
Fixed Cost Per Unit
Pairs of
Rollerblades
produced
1
10
400
500
Monthly
rental cost
$1,000
$1,000
$1,000
$1,000
Per unit
rental cost
$1,000
$100
$3
$2
Per Unit Rental Cost
How does the factory rental cost per unit of rollerblade
change as the number of rollerblades produced increases?
Rollerblades
produced
Quick Check
Fixed costs are usually characterized by:
a.
Unit costs that remain constant.
b.
Total costs that increase as activity decreases.
c.
Total costs that increase as activity increases.
d.
Total costs that remain constant.
Variable costs are usually characterized by:
a.
b.
c.
d.
Unit costs that decrease as activity increases.
Total costs that increase as activity decreases.
Total costs that increase as activity increases.
Total costs that remain constant.
Relevant Range
The range of activity within which the assumptions
about cost behavior are valid.
Total cost curve
Total
cost
Relevant
range
Activity Volume
Summary: Cost Behavior
Within the Relevant Range, how will each of the following
cost change as activity level increases (decreases)?
In Total
Variable Cost
Fixed Cost
Per Unit
Practice Problem
Luxor Company’s relevant range is 500 to 4000 units. The cost
information for producing 1500 units is as follows:
Total Fixed Cost
$120,000
Total Variable Cost
$360,000
Total production cost
$480,000
Calculate:
1) per unit variable cost if 3,000 units are produced;
2) per unit fixed cost if 2,500 units are produced;
3) Per unit production cost if 1,000 units are produced;
4) The total cost if 4,000 units are produced.
What if 5,000 units are produced?
Practice Problem
Nale company’s relevant range is from 200 to 2000 units.
In the past it produced 400 units with a total cost of $2200,
and 500 units with a total cost of $2700. Now if it want to
produce 800 units, what will be the expected total cost?
How accounting system reports costs?
Costing: In accounting, costing is largely a matter of assigning
costs to products or services.
Absorption Costing: The costing method used to value
inventories and cost of goods sold for financial reporting purposes.
Under absorption costing, all manufacturing costs are
treated as product costs, all non-manufacturing costs
are treated as period costs, regardless of whether they
are fixed or variable.
Product vs. Period Costs
Absorption costing differentiates product and period
costs based on the timing with which various costs are
recognized as expenses on the income statement
(according to GAAP).

Product Costs (Manufacturing Costs):
 Recognized as expense (cost of good sold) when
the product is sold

Period Costs (Non-Manufacturing Costs):
 Recognized as expense in the period incurred, no
matter the product is sold or not.
Accounting for manufacturing firm
The production process:
Purchase
materials
Use Materials, Labor,
Overhead to
make a product
Ready to sell
to customer
Accounting:
Raw Materials
Inventory
Work-in-Process
Inventory
Finished goods
Inventory
Cost of
Goods Sold
Manufacturing Costs
Direct
Labor
Direct
Material
Product Cost
Manufacturing
Overhead
Direct Material
Materials that become an integral part of the
product and that can be conveniently traced
directly to the product
Example:
Steel used to
manufacture
the automobile.
Direct Labor
Cost of wages for people who work directly on products.
In other words, those labor costs that can be easily traced to
individual units of product.
Example:
Wages paid to an
automobile assembly
worker.
Manufacturing Overhead
All other manufacturing costs that cannot be traced directly to
specific units produced. It includes any other costs that is related
to the manufacturing process or production facility (factory).
Indirect
Material
Indirect
Labor
Other
manufacturing Costs
Examples of other manufacturing costs:
Depreciation, maintenance and repairs of production equipment;
Utilities, insurance, property tax of the production facility (factory)
Examples of Manufacturing Overhead
Indirect
Labor
Wages paid to employees who
are not directly involved in
production work but is
associated with operating the
factory.
Examples: wages for
production supervisors,
maintenance workers, janitors
and security guards for the
factory
Indirect
Material
Materials used to support the
production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.
Cost Classification - Manufacturing Firms
Manufacturing costs are often combined as follows:
Direct
Labor
Direct
Material
Prime
Cost
Manufacturing
Overhead
Conversion
Cost
Nonmanufacturing Costs
Marketing and
Selling Costs
Administrative
Costs
Costs necessary to get the
order and deliver the
product. e.g. advertising,
shipping, sales
commissions.
All executive,
organizational, and clerical
costs.
Summary: Costs under Absorption Costing
Direct
Material
Direct
Labor
Manufacturing
Overhead
Manufacturing Costs = Product Costs
Marketing/
Selling Costs
Administrative
Costs
NonManufacturing Costs = Period Costs
Quick Check
For each of the following costs, answer whether it is:
DM, DL, MOH or Nonmanufacturing cost?
Prime and/or Conversion cost? Product or Period cost?
1). Manufacturing equipment depreciation.
2). Property taxes on corporate headquarters.
3). Wages paid to the production supervisor.
4). Electrical costs to light the production facility.
5). Wages paid to the factory machine operators.
6). The cost of a hard drive installed in a computer.
7). Sales commissions.
Cost Behavior: Accounting Costs
For each of the following costs, please specify whether it
is a fixed cost or variable cost within the relevant range?
Assume the cost driver is units of product produced:
1). Direct Material
2). Direct Labor
3). Property tax of the factory building
4). Electricity consumed to make the product
Assume the cost driver is units of product sold:
1). Sales Commission
2). Cost of one advertising campaign.
Economic Costs vs. Accounting Costs
Cost classification for decision making:
Differential Cost/Differential Revenue – Costs and revenues
that differ between two (or more) alternatives
Opportunity Cost – the potential benefit given up when one
alternative is selected over the next best alternative.
Sunk Cost – a cost that has already been incurred and cannot
be changed by any decision now or later.
Relevant costs for decision making
Every
decision involves a choice between at least
two alternatives.
Only
differential costs and benefits are relevant in
a decision. All other costs and benefits can and
should be ignored.
Is
Opportunity Cost a differential cost?
Is
Sunk Cost a differential cost?
Practice Problem: Equipment Replacement Decision
A manager at White Co. is deciding whether to replace an old
machine with a new machine. White’s sales are estimated to be
$200,000 per year for the next 5 years. Fixed expenses, other than
depreciation, are estimated to be $70,000 per year. Purchasing the
new machine costs $90,000 and will save variable expenses of
$20,000 per year during its 5-year useful life. The old machine was
purchased at $72,000 and carry a remaining book value of $60,000
on the balance sheet. The disposal value of the old machine is
$15,000. The old machine, if not used, could also be leased to
another company for $4,000 per year for the next 5 years.
Question: for this equipment replacement decision
(1) what are differential costs and revenues over the next 5 years?
(2) What is the opportunity cost for keep using the old machine?
(3) Is there any sunk cost?
For Next Class
Read Chapter 2, focus on product cost flows
Complete the assigned HW problems
Home Work: Q1
Answer Yes or No to each of the following question:
Wage paid to factory machine operators at $10 per
unit of product would be a:
(1) Period Cost?
(2) Conversion Cost?
(3) Fixed Cost?
(4) Prime Cost?
Home Work: Q2
Karvel Co.’s relevant range is 100 to 5000 units.
Last year 2,000 units were produced with
total production cost of $240,000, among which total
fixed cost is $60,000 and total variable cost is $180,000.
Q: What will be the per unit production cost if 1,000 units
are produced this year?
Home Work: Q3
Mastang Co.’s relevant range is 0 to 1000 units. In
April it produced 400 units with a total production cost
of $3,000. In May it produced 900 units with a total
production cost of $5,500.
Q: What will be the total production cost for June if 800
units are expected to be produced?