Ch 02: Managerial Accounting and Cost Concepts Managerial-KU

Introduction:
1. Many different kind of organization affect our daily lives, like…….
[Manufacturing – retailers – services- Nonprofit organization – government]

2. All of these organization have:

a. A set of Goals or objectives
b. Managers strive to achieve these goals
c. To achieve these goals :
 Managers need information. ( Comes from accounting system)
 And the day to day work of the management which are:-
 Planning
1. Identify alternatives.
2. Select the best alternative
3. Develop budgets for the selected alternative.
 Directing and motivating 1.
Employee work assignments.
2. Routine problem solving.
 Controlling
1. The control function ensures that plans are being followed.
2. Controlling is the process of comparing actual results with the
budget.
3. Feedbacks in the form of performance reports are an essential part of
the control function

3. Accounting System:
Is a part of the organization's management information system, which accumulate date for
use in both financial and managerial accounting
Ch 02: Managerial Accounting and Cost Concepts Managerial-KU
4. Types of accounting:
a. Financial Accounting
b. Managerial Accounting

Page 1 of 11 MANAGERIAL VERSUS FINANCIAL ACCOUNTING:

Financial accounting Managerial

External Persons Who make financial Managers (internal) who plan
Users
decisions for and control an organization
Reports Financial Statement Cost Reports
• Income statement • Cost of Goods Sold
• Retained Earning statement • Cost of Goods Available
• Balance sheet • Cost of Goods Manufactured
• Statement of cash flow
Time focus Historical Perspective Future emphasis
Verifiability Emphasis on relevance for
Emphasis on Verifiability
versus planning and control
Relevance

Precision
Emphasis on Precision Emphasis on Timeliness
versus
Timeliness

Primary focus is on the whole Focus on segments of an

Subject
organization organization
Must follow GAAP and prescribed Need not follow GAAP or any
GAAP
formats prescribed format
Requirement Mandatory for external reports Not Mandatory

5. Preparing of Cost Reports:

To prepare the cost reports we have first to understand what meant by cost.

Cost: is a sacrifice made by recourses to achieve a particular purpose.

Costs can be classified in a number of ways—depending on the purpose of the

classification-
1- Product and period : (Preparing external financial reports.
2- Manufacturing and Non-manufacturing : (Assigning costs to cost objects ).
3- Direct and indirect : ( the relationship between costs and Products)
4- Material, labor and overhead : ( Preparing Cost Budget )
5- Variable and Fixed : ( the relationship between costs and activity )
6- Controllable and Non-controllable : ( Making business Decisions )

Now let's look at various calcification of cots.

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Ch 02: Managerial Accounting and Cost Concepts Managerial-KU

Cost Classifications: (General Cost Classifications)

1 2 3

Product Costs Manufacturing

Direct Material (V)
Cost of goods sold Direct Prime Cost
Direct Labour (V)

Inventory Conversion Cost

Indirect Overhead (V,F,M)

Indirect Material
Period Costs Non - Manufacturing Indirect Labour

Other MOH
Marketing (selling)

Administrative Rental of Factory.

Depreciation on Plant, Equipment.
Utilities, Factory
Supplies, Factory
Insurance on Factory
Ch 02: Managerial Accounting and Cost Concepts Managerial-KU
Cost Classifications: ( 4 types of cost classifications )
1. Product and period Costs.

Product costs include all the costs that are involved in acquiring or making a product,
Product costs are also known as Inventorable costs.

Period costs include all selling costs and administrative costs, These costs are expensed on
the income statement in the period incurred.

2. Manufacturing and Non-Manufacturing Costs.

Manufacturing costs: includes a.

Direct Material.
Raw materials that become an integral part of the product and that can be conveniently
traced directly to it. Examples
the aircraft engines on a Boeing 777, the Intel
processing chip in a personal computer, the
blank video cassette in a pre-recorded video,
and a radio in an automobile.

b. Direct Labor.
Those labor costs that can be easily traced to individual units of product.
Examples
Wages paid to automobile assembly workers

c. Manufactory overhead
includes all manufacturing costs except direct materials and direct labor, These costs
cannot be easily traced to specific units (also called indirect manufacturing cost, factory
overhead, and factory burden).

 Indirect Materials.
Materials used to support the production process. Examples
lubricants and cleaning supplies used in the automobile assembly
plant.

 Indirect Labor.
Wages paid to employees who are not directly involved in production
work. Examples maintenance workers, janitors and security guards.

 Other manufactory overhead.

maintenance and repairs on production equipment, heat and light, property taxes,
depreciation and insurance on manufacturing facilities, etc.

Non-Manufacturing costs: includes a.

Selling Costs.
include all costs necessary to secure customer orders and get the finished product into the
hands of the customer

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Ch 02: Managerial Accounting and Cost Concepts Managerial-KU
Examples of selling costs include advertising, shipping, sales travel, sales commissions,
sales salaries, and costs of finished goods warehouses.
b. Administrative Costs.
include all executive, organizational, and clerical costs associated with the general
management of an organization.
Examples of administrative costs include executive compensation, general accounting,
secretarial, public relations, and similar costs involved in the overall general
administration of the organization as a whole.

3. Cost Classification for decision making:

1. Opportunity Cost.
Is the potential benefit given up when one alternative is selected over another.
2. Differential Cost (Incremental Cost) A difference in Cost between alternatives.
3. Sunk Cost.
Is a cost that has already been incurred and cannot be changed by any decision made now
or in the future.

4. Variable and Fixed Costs. (for predicting cost behavior)

A Variable cost
Varies in direct proportion to changes in the level of activity. For example, if you don’t have
a texting plan on your cell phone, text messaging costs 5 cents per text. Your total texting
bill increases with the number of texts you send.

Activity Cost Per Total Cost of

(Messages) Message Messages
100 5 Cents 500 Cents
200 5 Cents 1000 Cents
300 5 Cents 1500 Cents

A Fixed cost
is constant within the relevant range. In other words, fixed costs do not change for changes
in activity that fall within the “relevant range"

For example, your monthly contract fee for your cell phone is a fixed amount for a certain
number of minutes. The monthly contract fee does not change based on the number of calls
you make.

Relevant range:
The range of activity within which assumptions about variable and fixed cost behavior is
valid.

Note:
if you go over your monthly minutes allotment, you have exceed the relevant range for your
monthly contract and will be charged above and beyond your monthly contract fee.

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Ch 02: Managerial Accounting and Cost Concepts Managerial-KU

Activity Cost Per Total Cost of

(Minutes) Minute Calls
10 $10 $100
20 $05 $100
50 $02 $100

Types of fixed costs:

a. Committed fixed cost. Investments in facilities, equipment, and basic organizational
structure that can’t be significantly reduced without making fundamental changes.
b. Discretionary fixed cost
Those fixed costs that arise from annual decision by management to spend on certain
fixed cost item, such as advertising and research.

Summary of Variable and Fixed cost Behavior

Cost In Total Per Unit
Total variable cost changes as Variable cost per unit remains the same
Variable
activity level changes over wide range of activity
Remains the same, within relevant Fixed cost per unit goes down as activity
Fixed
Range level goes up

A Mixed cost (Semivariable cost)

A cost that contains both variable and fixed cost element

Cost Reports

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Ch 02: Managerial Accounting and Cost Concepts Managerial-KU

3- Cost of Goods Manufactured Statement

Direct Material
Beginning raw-material inventory ***
(+) purchases of raw material ***
(=) Raw material available for use ****
(-) Ending raw-material inventory (***)
(=) Raw material used (Direct Material) ****
Add: direct Labour ****
Add: Manufacturing Overhead
Indirect material ***
Indirect labour ***
Depreciation on factory ***
Depreciation on equipment ***
Manufacturing utilities ***
Insurance ***
= Total Manufacturing Overhead ………… ****
Total manufacturing costs ………… *****
Add: Beginning of the period work-in-process inventory ………… ****
Deduct: Cost of work-in-process inventory at year-end… ………… (****)
Cost of Goods Manufactured ………… ******

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Ch 02: Managerial Accounting and Cost Concepts Managerial-KU

Types of Income Statement

Traditional Format Contribution Format

Sales Sales 10,000

(-) Cost of Goods Sold (-) Variable expenses
(=) Gross Margin (Profit) Cost of Goods Sold 2,000
(-) Selling and Adminstrative Exp. Variable Selling 500
(=) Net Operating Income Variable administrative 1,500 4,000
(=) Contribution Margin 6,000
(-) Fixed expenses
Fixed Selling 1,000
Fixed administrative 500 1,500
(=) Net Operating Income 4,500

Understanding Cost Behavior ??

 Cost behavior refers to: How cost will react or changes as a change in the
level of Activity.
 Understanding cost behavior helps managers in Predicting Costs under
various levels of activity. How??
Let us Look at the following example.

Nour Company Produce 4,000 units at a total cost of $10,000.

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Ch 02: Managerial Accounting and Cost Concepts Managerial-KU

Segregation of Mixed Costs:

Managers can use a variety of method to estimate the fixed and variable
components of a mixed cost such as:

1- Account analysis approach

2- Engineering approach
3- Scattergraph plot
4- High low method
5- Least squares regression

High Low Method:

Is a cost-estimation method in which a cost line is fit using exactly two data points –
the high and low activity levels Exercise:

Nourhan Inc. has provided the following data concerning its maintenance costs:
Machine-Hours Maintenance Cost

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Ch 02: Managerial Accounting and Cost Concepts Managerial-KU

March .................... 4,440 $50,950

April ...................... 4,431 $50,877
May ........................ 4,412 $50,696
June ........................ 4,460 $51,113
July ........................ 4,414 $50,711
August ................... 4,433 $50,900
September .............. 4,443 $50,976
October .................. 4,415 $50,730
November .............. 4,439 $50,830

Management believes that maintenance cost is a mixed cost that depends

on machine-hours.
Required:

A) Estimate the variable cost per machine-hour and the fixed cost per
month using the high-low method.
B) Estimate the cost formula for maintenance cost.
C) Assume that the company plans to Work 5,000 Hours during
December , How much Maintenance Cost will be?

Solution:

A)Estimate the variable cost per machine-hour and the fixed cost per month using
the high-low method.

1- Selecting the High and Low activity and its related Costs:
2- Computing the Variable Cost per units [ Slop ] or [ b ].

3- Computing the fixed cost. a = Y – bX

= $51,113 – ( $8.678 ×4,460 ) = $12,409

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Ch 02: Managerial Accounting and Cost Concepts Managerial-KU

B) Estimate the cost formula for maintenance cost.

Y=a+bX
Y = $12,409 + $8.678 X

C) Assume that the company plans to Work 5,000 Hours during December , How
much Maintenance Cost will be?
Y = $12,409 + ( $8.678 X 5,000 hours ) = $55,799

Multiple choices:

Page 11 By: Ehab Abdou (97672930)

Ch 02: Managerial Accounting and Cost Concepts Managerial-KU
1- The variable costs per unit are $4 when a company produced 10,000 units of production .
what are the variable costs per unit when 8,000 units are produced ? a.
$ 4.00
b. $ 4.50
c. $ 5.00
d. $ 5.50
e. Some other amount

2- The fixed costs per unit are $10 when a company produced 10,000 units of product , what
are the fixed costs per unit when 12,500 units are produced ?
a. $ 4.00
b. $ 6.00
c. $ 8.00 ($10*10,000) / 12,500
d. $ 10.00
e. some other amount

3- Total costs are $80,000 when 8,000 units are produced ; of this amount, variable costs are
$48,000 , what are the total costs when 10,000 units are produced ?
a. $ 80,000 T.F.C = 80,000 – 48,000 = 32,000
b. $ 92,000 V.C/U = 48,000 / 8,000 = 6
c. $ 98,000 T.C = 32,000 + ( 6 * 10,000) = 92,000
d. $ 100,000
e. $ 108,000

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Exercise:
The following data were taken from the cost records of Morrey Company for last year:

Depreciation, factory $60,000

Indirect labor $100,000
Administrative salaries $14,000
Factory supervision $16,000
Advertising expenses $20,000

Page 12 By: Ehab Abdou (97672930)

Ch 02: Managerial Accounting and Cost Concepts Managerial-KU
Utilities, factory $40,000
Property taxes, (60% administrative,40% selling) $30,000
Insurance, factory $10,000
Depreciation, administrative office equipment $ 12,000
Lubricants for machines $15,000
Direct labor $200,000
Purchases of raw materials $150,000
Sales $900,000

Inventories at the beginning and at the end of the year were as follows:

Beginning Ending
Raw materials $10,000 $20,000
Work in process $25,000 $5,000
Finished goods $30,000 $50,000

Required:
Prepare a schedule of cost of goods manufactured.
Prepare a schedule of cost of goods sold.
Prepare income statement.

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Page 13 By: Ehab Abdou (97672930)