Chapter 1

An Introduction to
Managerial Accounting
and Cost Concepts

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 Work of Management

Planning
Planning
Directing
Directing and
and
Motivating
Motivating

Controlling
Controlling

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 Planning

Identify
Identify
alternatives.
alternatives.

Select
Select alternative
alternative that
that does
does
the
the best
best job
job of
of furthering
furthering
organization’s
organization’s objectives.
objectives.

Develop
Develop budgets
budgets to
to guide
guide
progress
progress toward
toward the
the
selected
selected alternative.
alternative.
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 Directing and Motivating
Directing and Motivating

Directing and motivating involves managing

day-to-day activities to keep the
organization running smoothly.
 Employee work assignments.
 Routine problem solving.
 Conflict resolution.
 Effective communications.

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 Controlling

The
The control
control function
function ensures
ensures
that
that plans
plans are
are being
being followed.
followed.

Feedback
Feedback inin the
the form
form ofof performance
performance reports
reports
that
that compare
compare actual
actual results
results with
with the
the budget
budget
are
are an
an essential
essential part
part of
of the
the control
control function.
function.

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 Planning and Control Cycle
Formulating
Formulatinglong-
long- Begin
and
andshort-term
short-termplans
plans
(Planning)
(Planning)

Comparing
Comparingactual
actual Implementing
Implementing
to
toplanned
planned Decision plans
performance Making plans(Directing
(Directing
performance and
(Controlling) andMotivating)
Motivating)
(Controlling)

Measuring
Measuring
performance
performance
(Controlling)
(Controlling)
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Comparison of Financial and Managerial
Accounting

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 Learning Objective
LO1

To identify and give

examples of each of the
three basic
manufacturing cost
categories

1-8
 Manufacturing Costs

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product

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 Direct Materials

Raw materials that become an integral part of

the product and that can be conveniently
traced directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile

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 Direct Labor

Those labor costs that can be easily traced to

individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers

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 Manufacturing Overhead

Manufacturing costs that cannot be traced directly to

specific units produced.
Examples:
Examples: Indirect
Indirect materials
materials and
and indirect
indirect labor
labor

Materials used to support Wages paid to employees

the production process. who are not directly
involved in production
Examples: lubricants and work.
cleaning supplies used in the Examples: maintenance
automobile assembly plant. workers, janitors and
security guards.

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 Classifications of Costs

Manufacturing costs are often

classified as follows:

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Material
Material Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost

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 Non-manufacturing Costs

Administrative
Selling Costs
Costs

Costs necessary to get All executive,

the order and deliver organizational, and
the product. clerical costs.

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 Learning Objective
LO2

To distinguish between
product costs and
period costs and give
examples of each

1-15
Product Costs Versus Period Costs
Product costs include Period costs are not
direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Cost of
Inventory Goods Sold
Expense

Sale

Balance Income Income

Sheet Statement Statement
1-16
 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.

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 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.

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 Comparing Merchandising and
Manufacturing Activities
Merchandisers . . . Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.

MegaLoMart

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 Balance Sheet

Merchandiser Manufacturer
Current assets Current Assets
 Cash ❖ Cash

 Receivables ❖ Receivables
❖ Prepaid Expenses
 Prepaid expenses
❖ Inventories:
 Merchandise
Raw Materials
inventory
Work in Process
Finished Goods

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 Balance Sheet

Merchandiser Manufacturer
Current assets Current Assets
 Cash ❖ Cash

 Receivables ❖ Receivables
Materials waiting to
❖ Prepaid Expenses
be processed.
 Prepaid expenses
Partially complete ❖ Inventories:
 Merchandise
products – some Raw Materials
inventory
material, labor, or Work in Process
overhead has been
Finished Goods
added.
Completed products
awaiting sale.
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 Learning Objective
LO3

To prepare an income
statement including
calculation of the cost of
goods sold

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 The Income Statement
Cost of goods sold for manufacturers differs only slightly from cost of
goods sold for merchandisers.

Merchandising Company
Cost of goods sold:
Beg. merchandise
inventory $ 14,200
+ Purchases 234,150
Goods available
for sale $ 248,350
- Ending
merchandise
inventory (12,100)
= Cost of goods
sold $ 236,250

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 Inventory Flows

Withdrawals
Withdrawals
Beginning
Beginning Additions
Additions Ending
Ending
balance
balance
+ to
to inventory
inventory
= balance
balance
+ from
from
inventory
inventory

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 Quick Check 

If your inventory balance at the beginning of

the month was $1,000, you bought $100
during the month, and sold $300 during the
month, what would be the balance at the end
of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.

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 Quick Check 

If your inventory balance at the beginning of

the month was $1,000, you bought $100
during the month, and sold $300 during the
month, what would be the balance at the end
of the month?
A. $1,000. $1,000 + $100 = $1,100
B. $ 800. $1,100 - $300 = $800
C. $1,200.
D. $ 200.

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 Learning Objective
LO4

To prepare the
schedule of cost of
goods manufactured

1-27
Schedule of Cost of Goods Manufactured

Calculates the cost of raw

material, direct labor and
manufacturing overhead used
in production.

Calculates the manufacturing

costs associated with goods
that were finished during the
period.
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Schedule of Cost of Goods Manufactured
Manufacturing Work
Raw Materials
The
The direct
Costs direct materials
materials cost
In Process cost is
is not
not
Beginning raw
simply
simply the the cost
cost of
of materials
materials
+
materials inventory
Raw materials
purchased
purchased during during the
the period—
period—
purchased rather
rather itit is
is the
the cost
cost of
of materials
materials
= Raw materials
available for use used
used duringduring the
the period.
period.
in production
– Ending raw materials
inventory
= Raw materials used
in production

1-29
Schedule of Cost of Goods Manufactured
Manufacturing Work
Conversion
Conversion
Raw Materials Costs In Process
costs
costsarearecosts
costs
Beginning raw Direct materials
materials inventory + Direct labor
incurred
incurredto to
+ Raw materials + Mfg. overhead convert
convert the
the
purchased = Total manufacturing
= Raw materials costs
direct
directmaterial
material
available for use into
into aafinished
finished
in production
– Ending raw materials
product.
product.
inventory
= Raw materials used
in production As
Asitems
items are
are removed
removedfrom
from raw
raw
materials
materialsinventory
inventoryandand placed
placedinto
into
the
the production
production process,
process, they
theyare
are
called
calleddirect
direct materials.
materials.
1-30
Schedule of Cost of Goods Manufactured
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory process inventory
= Raw materials used All
All manufacturing
manufacturing
= costs
costs incurred
incurred
Cost of goods
in production manufactured.
during
during the
theperiod
period are
are added
addedto tothe
the
beginning
beginning balance
balanceof
of work
work in
in
process.
process.

1-31
Schedule of Cost of Goods Manufactured
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory process inventory
= Raw materials used = Cost of goods
Costs
Costsassociated
associatedwith
in productionwiththe
the goods
goods that
that manufactured.
are
arecompleted
completed during
duringthe
the period
period are
are
transferred
transferredto
tofinished
finished goods
goods
inventory.
inventory.
1-32
Cost of Goods Sold

1-33
 Manufacturing Cost Flows
Balance Sheet Income
Costs Inventories Statement
Material Purchases Raw Materials Expenses

Direct Labor Work in

Process
Manufacturing
Overhead Finished Cost of
Goods Goods
Sold

Selling and Period Costs Selling and

Administrative Administrative

1-34
 Quick Check 

Beginning raw materials inventory was

$32,000. During the month, $276,000 of raw
material was purchased. A count at the end of
the month revealed that $28,000 of raw
material was still present. What is the cost of
direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000

1-35
 Quick Check 

Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000

1-36
 Quick Check 

Direct materials used in production totaled

$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.

1-37
 Quick Check 

Direct materials used in production totaled $280,000.

Direct labor was $375,000 and factory overhead was
$180,000. What were total manufacturing costs
incurred for the month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.

1-38
 Quick Check 

Beginning work in process was $125,000.

Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.

1-39
 Quick Check 

Beginning work in process was $125,000.

Manufacturing costs incurred for the month were
$835,000. There were $200,000 of partially
finished goods remaining in work in process
inventory at the end of the month. What was the
cost of goods manufactured during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.

1-40
 Quick Check 

Beginning finished goods inventory was

$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.

1-41
 Quick Check 

Beginning finished goods inventory was

$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
$130,000 + $760,000 = $890,000
B. $740,000. $890,000 - $150,000 = $740,000
C. $780,000.
D. $760,000.
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 Learning Objective
LO5

To define and give

examples of variable
costs and fixed costs

1-43
Cost Classifications for Predicting Cost
Behavior

How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
business
business activity.
activity.
 Total
 Total variable
variable costs
costs
change
change when
when activity
activity
changes.
changes.
 Total
 Total fixed
fixed costs
costs remain
remain
unchanged
unchanged when
when activity
activity
changes.
changes.
1-44
 Total Variable Cost

Your total long distance telephone bill is

based on how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
1-45
 Variable Cost Per Unit

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
1-46
 Total Fixed Cost

Your monthly basic telephone bill probably

does not change when you make more local
calls.
Telephone Bill
Monthly Basic

Number of Local Calls

1-47
 Fixed Cost Per Unit

The average fixed cost per local call

decreases as more local calls are made.

Monthly Basic Telephone

Bill per Local Call
Number of Local Calls
1-48
Cost Classifications for Predicting Cost
Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.

1-49
 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.

1-50
 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.

1-51
 Learning Objective
LO6

To define and give

examples of direct and
indirect costs

1-52
 Assigning Costs to Cost Objects

Direct costs Indirect costs

 Costs that can be  Costs that cannot be
easily and conveniently easily and conveniently
traced to a unit of traced to a unit of
product or other cost product or other cost
object. object.
 Examples: direct  Example:
material and direct manufacturing
labor overhead

1-53
 Learning Objective
LO7

To define and give

examples of cost
classifications used in
making decisions:
differential costs,
opportunity costs, and
sunk costs

1-54
Cost Classifications for Decision Making

 Every decision involves a choice between at

least two alternatives.

 Only those costs and benefits that differ

between alternatives are relevant in a
decision. All other costs and benefits can
and should be ignored.

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 Differential Costs and Revenues

Costs and revenues that differ among

alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.

Differential revenue is:

$2,000 – $1,500 = $500

Differential cost is:

$300
1-56
 Opportunity Costs
The potential benefit that
is given up when one
alternative is selected
over another.
Example: If you were
not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for
one year is $15,000.
1-57
 Sunk Costs
Sunk costs cannot be changed by any
decision. They are not differential costs and
should be ignored when making decisions.
Example: You bought an automobile that cost $10,000
two years ago. The $10,000 cost is sunk because
whether you drive it, park it, trade it, or sell it, you cannot
change the $10,000 cost.

1-58
 Quick Check 

Suppose you are trying to decide whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not
relevant.
1-59
 Quick Check 

Suppose you are trying to decide whether to drive or

take the train to Portland to attend a concert. You
have ample cash to do either, but you don’t want to
waste money needlessly. Is the cost of the train
ticket relevant in this decision? In other words,
should the cost of the train ticket affect the decision
of whether you drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not
relevant.

1-60
 Quick Check 

Suppose you are trying to decide whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either,
but you don’t want to waste money
needlessly. Is the annual cost of licensing your
car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

1-61
 Quick Check 

Suppose you are trying to decide whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either,
but you don’t want to waste money
needlessly. Is the annual cost of licensing your
car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

1-62
 Quick Check 

Suppose that your car could be sold now for

$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

1-63
 Quick Check 

Suppose that your car could be sold now for

$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

1-64
 Summary of the Types of Cost
Classifications

 Financial reporting
 Predicting cost behavior
 Assigning costs to cost objects
 Decision making

1-65
End of Chapter 1

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