Chapter 2 Lecture Notes

Managerial Accounting and Cost Concepts

GENERAL COST CLASSIFICATIONS
MANUFACTURING COSTSgenerally all costs related to making a product
Direct Materials (DM)
Direct Labor (DL) (a.k.a., touch labor)
Manufacturing Overhead (MOH) costs include all costs of manufacturing
the product except for the costs already included in DM and DL.
NON-MANUFACTURING all other cost NOT related to making the product,
expensed when incurred.
Marketing or selling costs
-Costs necessary to get the order and deliver the product
Administration costs
-All executive, organizational, and clerical costs
Practice
The Dell assembles custom computers from components supplied by various
manufacturers. For each cost, indicate whether it would most likely be
classified as DM, DL, MOH, marketing & selling, or administrative.
DM DL MOH M & Admi
S
n
1 The cost of a hard-drives
2 The cost of advertising on TV
3 The wages of employees who assemble the
PCs
4 Sales commissions paid to the companys
salespeople
5 The wages of the assembly shops supervisor
6 The wages of the companys accountant
7 Depreciation on equipment used to test
assembled PCs
PRODUCT COSTS VERSUS PERIOD COSTS
Product Costs
Product costs are those costs that attach to units of product that are
purchased or manufactured.
--inventoriable costs (they are assets first then become an expense when the
product is sold)
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Period Costs (they become expenses as they are incurred)

Practice
Produc
t
1.
2.
3.
4.
5.
6.
7.
8.

Period

Depreciation on salespersons cars

Rent on equipment used in the factory
Lubricants used for maintenance of factory machines
Salaries of finished goods warehouse personnel
Soap and paper towels used by factory workers at the end
of a shift
Factory supervisors salaries
Advertising costs
The cereal box for Frosted Flakes

Prime Cost = DL + DM
Conversion Cost = DL + MOH
Exhibit 2-1 page 28 (Summary of Cost Terms)
BALANCE SHEET Inventory (Product)
Raw Materials
Work in Process
Finished Goods
INCOME STATEMENTCost of Goods sold (Product) or Operating expenses
(Period)

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Chapter 2

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Cost Classification for Predicting Cost Behavior

Cost Behavior
Cost structure
Types of Fixed Costs
- Committed Fixed Costs: long term in nature; they relate to the
investment in facilities, equipment and basic organizational structure; they
cannot be significantly reduced even for short periods of time without
seriously impairing the profitability or long-run goals of the organization.
- Discretionary Fixed Costs: short term in nature; they arise from annual
decisions by management; they can be cut for short periods of time with
minimal damage to the long-run goals of the organization.
Practice
Classify the following fixed costs as normally being either committed or
discretionary:
Committed

Discretionar
y

Depreciation on building
Research
Long term equipment lease
Pension payments to the companys
retirees
Management development and
training
Data Points

Fixed Costs (FC) Exhibit 2-2 page 30

$1,50
$5
0
$3
$1,25
$2.
0
5
$1,00
$2
0
$1
$750
$.5
$500
$0
Chapter 2

X
1
100
250
500
1000

Y
$500
$500
$500
$500
$500

Per
Guest

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Data Points

$25
0
$0
1
500

100

250
1000
# of guests

1
500

Total fixed cost

100

250

1000
# of guests

Fixed cost per

unit

X
1
100
250
500
1000

Y
$30
$3,000
$7,500
$15,00
0
$30,00
0

Per
Guest

Variable Costs (VC) Exhibit 2-2 page 30

Activity Base (cost driver)
$37,5
00
$30,0
00
$22,5
00
$15,0
00
$7,50
0
$30

$5
0
$4
0
$3
0
$2
0
$1
0
$0
1
1000

100

250

500

1
100
1000

250

500

# of guests

# of guests

Total variable cost

Variable cost per unit

The Linearity Assumption and the Relevant Range

Exhibit 2-3 page 32
- economists curvilinear cost function (supply curve)
- accountants straight-line approximation (Y = a + bX) the former Y = mx +
b
Mixed Costs Exhibit 2-6 page 34
The Analysis of Mixed Costs
For planning and control purposes, mixed costs should be broken down into
variable and fixed components to make it easier for management to make
forecasts.
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Scattergraph plot of data points help reveal trend

Least-Squares Regression Exhibit 2-11 page 41
Y = a + bX
R2
- goodness of fit
- variation in the dependent variable (total cost) due to changes in the
independent variable (activity)
- higher percent means more accurate forecast (X is a good predictor of Y)

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The High-Low Method Exhibit 2-10 page 40

Step 1: Determine VC
Activity

Total Cost

High
Low
Change
Variable costs
=

Change in Cost
Change in
activity

= $____ per activity

Step 2: Determine FC
Step 3: Determine Equation of the cost line:
Step 4: Solve for any level of X (within the relevant range)
Practice:
Espresso Cafe operates a number of Espresso Coffee stands in
busy suburban malls. Following are the costs for two weeks (total cost per week
and average cost per cup).

1.

Total Cost per week

Cost per cup of coffee
served

Cups of coffee served per

week
2,000 cups
2,400 cups
$1,640
$1,728
$0.82 per
$0.72 per
cup
cup

Why does
the
cost per
week change? And why does the cost per cup of coffee served change?

2.

Determine the Variable cost per cup of coffee:

3.

Determine the Fixed cost per week.

4.

Determine the cost equation for Espresso Express. Y = _______________

5.

Determine the expected cost for 2,200 cups served.

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Practice
The Lakeshore Hotels guest-days of occupancy and custodial supplies
expenses over the last few months were:
Month
Guest-Days of
Custodial Supplies
Occupancy
Expense
March
7,000
$8,400
April
6,500
$7,945
May
8,000
$9,520
June
10,500
$12,000
July
12,000
$13,500
Guest-days are a measure of the overall activity at the hotel. For example, a
guest who stays at the hotel for three days is counted as three guest-days.
1.

Using the high-low method, determine

the Custodial Supplies Expense variable cost
per guest day.

2.

Using the high-low method, determine the fixed cost for Custodial
Supplies Expense.

3.

What is the cost equation for Custodial Supplies Expense? Y =

______________

4.

If in August they estimate their Guest Days to be 11,200 what is their

estimated custodial supplies expense?

Practice
Corp XYZ has the following costs; determine which are fixed, variable or
mixed:
Total cost
Expe
4,000
5,000
Cost
Comment
nse
units
units
Type
1
$240,00 $300,00
0
0
2
$21,000 $21,000
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3
4
5

$34,000
$78,000
$12,000

$42,000
$89,000
$15,000

Determine the cost equation for Expense 3

Determine the cost equation for Expense 4

What would happen to expense 4 if activity increased?

Total:
Per Unit:
The Income Statement: Traditional Format versus Contribution
Format
Exhibit 212, page 42

The traditional income statement (learned

in financial accounting) organizes costs
based on PRODUCT versus PERIOD.

ABC, Inc.
Contribution Income Statement
For the Month Ended Augusts 31st
Per
Total
Unit
Sales
Less
Variable
Expenses
Contribution
Margin
Less
Fixed
Expenses
Net
Operating
Income

The contribution income statement organizes costs based on VARIABLE

versus FIXED.
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Variable Expenses include ALL variable costs expensed to the income

statement during the accounting period (both product and period).
Variable expenses include DM, DL, VMOH and VS&A expenses

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Complete the following Contribution format income statement using Y =

$78,000 + 79X and sales of 4,000 units at $100 each.
Total

Per Unit

Sales
Less Variable Expenses (both product &
period)
Contribution Margin
Less Fixed Expenses
Net operating income
If sales increase 1 unit, how much will net operating income increase?
Practice
PARK Company manufactures and sells a single product.
A partially
completed schedule of the companys total and per unit costs over a relevant
range of 60,000 to 100,000 units produced and sold each year is given
below:
Units Produced and
60,000
100,000
Sold
units
units
Total Costs:
Variable costs
$150,000
Fixed costs
360,000
Total costs
$510,000
Cost per unit:
Variable cost
Fixed cost
Total cost per unit
1. Complete the above schedule of the companys total and unit costs.
2. Assume the company produces and sells 90,000 units during the year at
the selling price of $7.50 per unit. Prepare a contribution format income
statement for the year.
Total
Per Unit
Sales
Less Variable Expenses
Contribution Margin
Less Fixed Expenses
Net operating income
ASSIGNING COSTS TO COST OBJECTS
Cost object is anything that management wants to get cost data on
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Direct Costs
-easily and conveniently traced
Indirect Costs
-cannot be easily and conveniently traced
Common costa cost incurred to support a number of cost objects but
cannot be directly traced to any of them individually.
Practice
Northwest Hospital is a full-service hospital that provides everything from
major surgery and emergency room care to outpatient clinics. For each cost
incurred at Northwest indicate whether it would most likely be a direct cost
or indirect cost to the specified cost object.
Direct Indirec
Cost
Costing object
Cost
t Cost
1 The wages of pediatric
The pediatric department
.
nurses
2 Prescription drugs
A particular patient
.
3 Heating the hospital
The pediatric department
.
4 The salary of the head of
The pediatric department
.
pediatrics
5 The salary of the head of
A particular pediatric
.
pediatrics
patient
COST CLASSIFICATIONS FOR DECISION MAKING
Differential Cost and Revenue
(incremental or decremental)
Marginal cost concept (marginal cost/marginal revenue)
Differential cost can be either fixed or variable.
Opportunity Cost
Opportunity cost is the potential benefit that is given up when one
alternative is selected over another. (Examples on pages 45-46)
Sunk Cost
A cost that has already been incurred and cannot be changed.

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