Learning Objective 1
Identify the major
differences and similarities
between financial and
managerial accounting.
Basics
• Managerial accounting concepts are most
relevant for manufacturing companies,
although it can be applied to merchandising
and service companies, as well.
• Reports are prepared mainly for internal use
and decision-making
• No required format; in whatever is desired by
management
Comparison of 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. GAAP
Must follow GAAP
and prescribed formats
Need not follow GAAP
or any prescribed format
Mandatory for
external reports
Not
Mandatory
1. Users
2. Time focus
7. Requirement
Learning Objective 2
Identify and give examples of
each of the three basic
manufacturing cost
categories.
Manufacturing Costs
Direct
Materials
Direct
Labor
The Product
Manufacturing
Overhead
Direct Materials
Raw materials that become an integral
part of the product and that can be
conveniently traced directly to it.
Example: A radio installed in an automobile
Direct Labor
Those labor costs that can be easily traced
to individual units of product.
Example: Wages paid to automobile assembly workers
Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect materials and indirect labor
Materials used to support the
production process.
Wages paid to employees who
are not directly involved in
production work.
Examples: lubricants and cleaning
supplies used in the automobile
assembly plant.
Examples: maintenance workers,
janitors and security guards.
Other cost considerations
1. Product vs period costs
2. Differences in the current assets of a merchandising company
and a manufacturing company
3. Presentation of the income statement under various
considerations
4. Variable and fixed costs
6. Cost classifications for predicting cost behavior
7. Direct and indirect costs
8. Cost-Volume-Profit analysis
8. Variable costing and absorption costing
Product Costs Versus Period Costs
Product costs include direct
materials, direct labor, and
manufacturing overhead.
Inventory
Cost of Good Sold
Period costs include all selling
costs and administrative
costs.
Expense
Sale
Balance
Sheet
Income
Statement
Income
Statement
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.
E. Sales commissions.
Cost classifications for predicting cost
behavior
How a cost will react to changes in the level of activity
within the relevant range.
 Total variable costs change when activity changes.
 Total fixed costs remain unchanged when activity changes.
 Some costs are semi-variable or mixed.
(Relevant range is defined as the range of activity over
which a company expects to operate during a year)
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.
Average fixed cost per unit goes
down as activity level goes up.
Mixed Costs
Costs that have
both a variable
cost element
and a fixed
cost element
Sometimes called
semivariable cost
Change in total but
not
proportionately
with changes in
activity level
Illustration 18-5
Mixed or Semi-variable costs
• Methods of breaking the cost down into its
fixed and variable components:
1.
2.
3.
4.
Scattergraph method
High-low method
Least-squares regression analysis
Multiple regression analysis
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.
Examples of Variable Costs
1. Merchandising companies – cost of goods sold.
2. Manufacturing companies – direct materials, direct
labor, and variable overhead.
3. Merchandising and manufacturing companies –
commissions, shipping costs, and clerical costs such
as invoicing.
4. Service companies – supplies, travel, and clerical.
Quick Check 
Which of the following statements about
cost behavior are true?
a. Fixed costs per unit vary with the level of
activity.
b. Variable costs per unit are constant within the
relevant range.
c. Total fixed costs are constant within the
relevant range.
d. Total variable costs are constant within the
relevant range.
Contribution format income statement
The contribution margin format emphasizes cost behavior. All items in the
income statement are re-classified as to fixed and variable costs.
Starting item (Sales) and the bottom line (Net Income) are the same in both
the traditional income statement and a contribution format income
statement. The difference is how the costs in between these two items
contribute to the analysis.
In the latter, after all costs have been re-classified, variable costs are
subtracted from total sales to arrive at the contribution margin. This margin
covers fixed costs and a certain level of profit, thus the term contribution
margin. (Note that some operating expenses may be variable.)
As you will see, this is a very powerful analysis tool and answers “what if?”
questions.
Uses of the Contribution Format
The contribution income statement format is used as an
internal planning and decision-making tool. This
approach will be used for:
1.Cost-volume-profit analysis
2.Budgeting
3.Segmented reporting of profit data
4.Special decisions such as pricing and make-or-buy
analysis.
Here, we will only look at #1 above.
The Contribution Format
Sales Revenue
Less: Variable costs
Contribution margin
Total
$ 100,000
60,000
$ 40,000
Less: Fixed costs
Net operating income
30,000
$ 10,000
Unit
$ 50
30
$ 20
The contribution margin format emphasizes cost
behavior. Contribution margin covers fixed costs and
provides for income.
The Contribution Format
Used primarily for
external reporting.
Used primarily by
management.
Basics of Cost-Volume-Profit
Analysis
The contribution income statement is helpful to managers in judging
the impact on profits of changes in selling price, cost, or volume. The
emphasis is on cost behavior.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Sales (500 bicycles)
$
250,000
Less: Variable expenses
150,000
Contribution margin
100,000
Less: Fixed expenses
80,000
Net operating income
$
20,000
Contribution Margin (CM) is the amount remaining from sales
revenue after variable expenses have been deducted.
Basics of Cost-Volume-Profit Analysis
The contribution income statement is helpful to managers in judging the
impact on profits of changes in selling price, cost, or volume The emphasis is
on cost behavior. Example:
Racing Bicycle Company
Contribution Income Statement
For the Month of June 2011
Sales (500 bicycles)
Less: Variable expenses
Contribution margin
Less: Fixed expenses
Net Income
250,000
150,000
100,000
80,000
20,000
Basics of Cost-Volume-Profit Analysis
Suppose there is a 10% increase in sales, how would it affect net income?
Racing Bicycle Company
Contribution Income Statement
For the Month of June 2011
550 bicycles
Sales (500 bicycles)
250,000
$275,000
Less: Variable expenses 150,000
165,000
Contribution margin
100,000
110,000
Less: Fixed expenses
80,000
80,000
Net Income
20,000
30,000
Basics of Cost-Volume-Profit Analysis
Suppose the company believes that by increasing advertising by $10,000 next
month, sales would increase by 25 bicycles. Should the company spend for
the additional advertising?
Racing Bicycle Company
Contribution Income Statement
For the Month of June 2011
Sales (500 bicycles)
Less: Variable expenses
Contribution margin
Less: Fixed expenses
Net Income
250,000
150,000
100,000
80,000
20,000
CVP/Profit Graph
Prepare and interpret a costvolume-profit (CVP) graph
and a profit graph.
CVP/Profit/Breakeven Graph
Use the contribution margin ratio
(CM ratio) to compute changes in
contribution
margin and net operating income
resulting from
changes in sales volume.
Short problems
• Gayne Corporation's contribution margin ratio is
12% and its fixed monthly expenses are $84,000.
If the company's sales for a month are $738,000,
what is the best estimate of the company's net
operating income? Assume that the fixed
monthly expenses do not change.
• A) $565,440
• B) $654,000
• C) $88,560
• D) $4,560
Short problems
•
•
•
•
•
•
Data concerning Kardas Corporation's single product appear below:
•
The company is currently selling 8,000 units per month. Fixed expenses are $719,000
per month. The marketing manager believes that a $20,000 increase in the monthly
advertising budget would result in a 180 unit increase in monthly sales. What should be the
overall effect on the company's monthly net operating income of this change? (show
shortcut).
A) decrease of $160
B) increase of $20,160
C) decrease of $20,000
D) increase of $160
•
•
•
•
Per Unit
Selling price
$140
Variable expenses
28
Contribution margin $112
Percent of Sales
100%
20%
80%
Variable Costing
• What are variable costing and absorption costing?
• Absorption costing is what we learned in cost accounting, i.e.,
consider all costs in determining unit cost ; therefore, fixed
overhead manufacturing costs are product costs.
• Variable costing considers only variable costs; therefore, all
fixed expenses are considered as period costs.
• (The difference is in the computation of unit product cost.)
Overview of Absorption and
Variable Costing
Absorption
Costing
Variable
Costing
Direct Materials
Product
Costs
Direct Labor
Product
Costs
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Period
Costs
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
Period
Costs
Unit Cost Computations
Harvey Company produces a single product
with the following information available:
Unit Cost Computations
Unit product cost is determined as follows:
Under absorption costing, all production costs, variable and
fixed, are included when determining unit product cost. Under
variable costing, only the variable production costs are included
in product costs.
Income Comparison of
Absorption and Variable Costing
Let’s assume the following additional information
for Harvey Company.
– 20,000 units were sold during the year at a price
of $30 each.
– There is no beginning inventory.
Now, let’s compute net operating
income using both absorption
and variable costing.
Absorption Costing
Fixed manufacturing overhead deferred in inventory is
5,000 units × $6 = $30,000.
Variable Costing
Variable
manufacturing
costs only.
Variable Costing
Sales (20,000 × $30)
Less variable expenses:
Beginning inventory
$
Add COGM (25,000 × $10)
250,000
Goods available for sale
250,000
Less ending inventory (5,000 × $10)
50,000
Variable cost of goods sold
200,000
Variable selling & administrative
expenses (20,000 × $3)
60,000
Contribution margin
Less fixed expenses:
Manufacturing overhead
$ 150,000
Selling & administrative expenses 100,000
Net operating income
$ 600,000
All fixed
manufacturing
overhead is
expensed.
260,000
340,000
250,000
$ 90,000
Variable Costing
• What is the difference between variable costing and absorption costing?
The difference is only in the treatment of fixed manufacturing overhead in
inventory.
• Why is absorption costing not appropriate in decision making? Absorption
costing does not dovetail with CVP analysis, nor does it support
decision making. It treats fixed manufacturing overhead as a
variable cost. It assigns per unit fixed manufacturing overhead costs
to production.
• (Explain: “fixed manufacturing overhead deferred in inventory”, and “fixed
manufacturing overhead released from inventory”.)
• When do the net operating incomes under both approaches equal?
Quick Check 
Which method will produce the highest
values for work in process and finished
goods inventories?
a. Absorption costing.
b. Variable costing.
c. They produce the same values for these
inventories.
d. It depends. . .