Chapter 2 Managerial Accounting and Cost Concepts General Cost Classifications Manufacturing costs can be separated into 3 categories direct materials direct labor manufacturing overhead Raw materials the materials that go into the final product Direct materials are those materials that become an integral part of the finished product and whose costs can be conveniently traced to the finished product Indirect materials insignificant materials such as glue included as part of manufacturing overhead Direct labor consists of labor costs that can be easily traced to individuals units of product assembly line workers Indirect labor costs that cannot be physically traced to particular products or that can be traced only at great cost and inconvenience part of manufacturing overhead janitors supervisors ect Manufacturing overhead all manufacturing costs except direct materials and direct labor Nonmanufacturing costs o Selling costs include all costs that are incurred to secure customer orders and get the finished product to the customer o Administrative costs include all costs associated with the general management of an organization rather than with manufacturing or selling Product Costs versus Period Costs Product costs include all costs involved in acquiring or making a product aka inventoriable costs bc they are initially assigned to inventories product costs are treated as expenses in the period in which the related products are sold Period costs are all the costs that are not product costs all selling and administrative expenses are treated as period costs Prime cost is the sum of direct materials cost and direct labor cost Conversion cost is the sum of direct labor cost and manufacturing overhead cost organization Cost Classifications for Predicting Cost Behavior Cost behavior refers to how a cost reacts to changes in the level of activity Cost structure the relative proportion of each type of cost in an Costs are categorized as variable fixed or mixed Variable cost varies in direct proportion to changes in the level of activity variable cost must be variable with respect to something that something is called an activity base is a measure of whatever causes the incurrence of a variable cost Fixed cost is a cost that remains constant regardless of changes in the level of activity as the number of guests increase the average fixed cost per guest drops Committed fixed costs represent organizational investments with a multiyear planning horizon that cant be significantly reduced even for short periods of time without making fundamental changes Discretionary fixed costs aka managed fixed costs usually arise from annual decisions by management to spend on certain fixed cost items can be cut for short periods of time with minimal damage to the long run goals of the organization Relevant range is the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid Mixed cost contains both variable and fixed cost elements aka semi variable costs The Analysis of Mixed Costs The fixed portion of a mixed cost represents the minimum cost of having a service ready and available for use The variable portion represents the cost incurred for actual consumption of the service Methods to estimate the fixed and variable components of mixed cost o Account analysis an account is classified as either fixed or variable based on the analyst s prior knowledge of how the cost in the account behaves o Engineering approach involves a detailed analysis of what cost behavior should be based on an industrial engineer s evaluation of the production methods to be used the materials specifications labor requirements equipment usage production efficiency power consumption and so on o High low and least squares regression methods estimate the fixed and variable elements by analyzing past records of cost and activity data Step 1 make a scattergraph plot must be linear in order to proceed o High low method is based on the rise over run formula for the slope of a straight line slope of the straight line is equal to the variable cost per unit of activity variable cost slope of the line run over run y2 y1 x2 x1 cost at high activity level cost at low activity level high activity level low activity level Step 1 identify period with the lowest level of activity the period with the highest level of activity Disadvantages only use 2 points and these 2 points are extremes unusual o Least squares regression method uses all of the data to separate a mixed cost into its fixed and variable components More accurate than the high low method Cost behavior is considered linear whenever a straight line is a reasonable approximation for the relation between cost and activity Traditional and Contribution Format Income Statements Sales COGS gross margin Gross margin selling and administrative expenses net operating income COGS reports the product costs Traditional income statement useful for external reporting purposes but Selling and administrative expenses report all period costs does not differentiate between variable and fixed costs so we also have the contribute format income statement Contribution approach provides managers with an income statement that clearly distinguishes between fixed and variable costs and therefore aids planning controlling and decision making o Sales variable expenses COGS included here contribution margin o Contribution margin fixed expenses net operating income Cost Classifications for Assigning Costs to Cost Objects Cost object is anything for which cost data are desired products customers jobs ect costs are classified as either direct or indirect to help assign costs to cost objects Direct cost is a cost that can be easily and conveniently traced to a specified cost object Indirect cost is accost that cannot be easily and conveniently traced to a specified cost object o Common cost is accost that is incurred to support a number of cost objects but cannot be traced to them individually manager s salary Cost Classifications for Decision Makin Differential cost a difference in costs between any two alternatives aka incremental cost Differential revenue a difference in revenues between an two alternatives Opportunity cost is the potential benefit that is given up when one alternative is selected over another Sunk cost a cost that has already been incurred and that cannot be changed by any decision made now or in the future Appendix 2A Least squares regression method
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