BUS 215; Banfield, Week 2 Chapter 2 Notes
BUS 215; Banfield, Week 2 Chapter 2 Notes BUS 215
Popular in Managerial Accounting
verified elite notetaker
Popular in Business
This 11 page Class Notes was uploaded by Charissa Loo on Monday April 18, 2016. The Class Notes belongs to BUS 215 at California Polytechnic State University San Luis Obispo taught by BanField in Spring 2016. Since its upload, it has received 45 views. For similar materials see Managerial Accounting in Business at California Polytechnic State University San Luis Obispo.
Reviews for BUS 215; Banfield, Week 2 Chapter 2 Notes
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 04/18/16
Bus 215 Chapter 2: Managerial Accounting and Cost Concepts Managerial accounting has many types of costs and are classified differently according to immediate needs of management. Ex: Prep of external FR requires the use of historical cost data, whereas decision making may require predictions about future costs. This notion odifferent costs for different purposis important. I. Cost Classifications for Assigning Costs to cost objects A. Exhibit 21 summarizes the cost classifications that will be defined in this chapter, namely cost classifications ■ B. A cost object is anything for which cost data are desired including products, customers, jobs and organizational subunits. For purposes of assigning costs to cost objects, cost are classified as edirectorindirect. C. Direct Cost ■ A direct cost is a cost that can be easily and conveniently traced to a specified cost object. ■ Ex: Reebok assigning cost to various reg and national sales offices, salary of sales manager in Tokyo office would be direct cost of that office. ■ Ex: printing company made 10,000 brochure for spec customer, cost of paper is direct cost of customer D. Indirect Cost ■ An indirect costis a cost that cannot be easily and conveniently traced to a specified cost object. ● EX: Campbell soup factory produce dozens of variety of soup. Factory’s managers salary is indirect cost of a particular variety of soup. His salary is consequence of running whole factory not just one soup. ● To be traced to a cost object such as a particular product,the cost must be caused by the cost object. Managers salary is acommon cost. ■ A common cost is a cost that is incurred to support a number of cost objects but cannot be traced to them individually. Common cost is a type of indirect cost. ■ May be direct or indirect depending on cost object. Salarindireccost of manufacturing chicken noodle soup, directcost of manufacturing division. → cost object is entire manufacturing division. II. Cost Classifications for Manufacturing Companies Two broad categories of costs: A. Manufacturing Costs: 2 types direct costs, 1 indirect ■ 2 types direct costs ● Direct Materials/indirect ○ The materials that go into the final product are caraw materials. (a) Any materials that are used in final product not just wood pulp or iron ore. → the finished product of one company can be the raw material of another. ○ Raw materials may include both directand indirect materia. (a) Direct materials are those materials that become an integral part of the finished product and whose costs can be traced to the finished product. This would include, for ex, the seats that Airbus purchases from subcontractors to install in its commercial aircraft and the electronic components that Apple uses in its iphones. (b) Indirect materialare not as important and are included as part of manufacturing overhead. ● Direct Labor ○ Direct labo consists of labor costs that can be easily traced to individual units of product. Direct labor is sometimes caltouch laborbecause direct labor workers typically touch the product while being made. (a) assembly line workers at Toyota ○ Labor costs that cannot be physically traced to particular products, or that can be traced only at great cost and inconvenience, are terlimited labor. (a) Treated as part of manufacturing overhead (b) Includes the labor costs of janitors, supervisors, material handlers and night security guards (c) impractical/impossible to accurately trace their costs to spec units of product → labor costs are treated as indirect labor. ■ Indirect cost: manufacturing overhead ● Manufacturing overhead , the third manufacturing cost category, includes all manufacturing costs except direct materials and direct labor. ○ items such as indirect materials; indirect labor; maintenance and repairs on production equipment; and heat and light, property taxes, depreciation, and insurance on manufacturing facilities. ○ those costs associated withoperating the factory are included in manufacturing overhead. ● Also called those costs associated withoperating the factor are included in manufacturing overhead. B. Nonmanufacturing Costs: two categories ■ selling costs ● elling costs include all costs that are incurred to secure customer orders and get the finished product to the customer. ● These costs are sometimes called ordergetting andorderfilling costs. ● Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses. ● can be either direct or indirect costs ■ Administrative costs ● include all costs associated with the general management of an organization rather than with manufacturing or selling. ● Ex: include all costs associated with tgeneral management of an organization rather than with manufacturing or selling. ● can be either direct or indirect costs. ○ salary of an accounting manager in charge of accounts receivable collections in the East region is a direct cost of that region ○ salary of a chief financial officer who oversees all of a company’s regions is an indirect cost with respect to individual regions. ● Also called selling, general, and administrative (SG&A) costs or just selling and administrative costs. III. Class Classifications for Preparing Financial Statements companies need to classify their costs aroduct costs orperiod costs costs are recognized as expenses on the income statement in the period that benefits from the cost The unexpensed portion of the insurance payment is carried on the balance sheet as an asset called prepaid insurance. matching principle is based on theaccrual concept thatcosts incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized. if a cost is incurred to acquire or make something that will eventually be sold, then the cost should be recognized as an expense only when the sale takes place—that is, when the benefit occurs. Such costs are calledproduct costs. A. Product Costs ■ product costs include all costs involved in acquiring or making a product. ■ consist of direct materials, direct labor, and manufacturing overhead ■ Product costs “attach” to units of product as the goods are purchased or manufactured, and they remain attached as the goods go into inventory awaiting sale. ■ Product costs are initially assigned to an inventory account on the balance sheet. → When goods are sold, the costs are released from inventory as expenses (typically called cost of goods sold) ● → and matched against sales revenue on the income statement. ■ Because product costs are initially assigned to inventories, they are also kinventoriable costs. ■ product costs are not necessarily recorded as expenses on the income statement in the period in which they are incurred. Only after they are sold. B. Period Costs ■ Period costs are all the costs that are not product costs. ■ All selling and administrative expenses are treated as period costs. ■ EX: sales commissions, advertising, executive salaries, public relations, and the rental costs of administrative offices are all period costs. ■ not included as part of the cost of either purchased or manufactured goods; i ● instead, period costs are expensed on the income statement in the period in which they are incurred using the usual rules of accrual accounting. ■ period in which a cost is incurred is not necessarily the period in which cash changes hands. ● For example, as discussed earlier, the costs of liability insurance are spread across the periods that benefit from the insurance—regardless of the period in which the insurance premium is paid. ACCRUAL ACCTING C. Prime Cost and Conversion Cost ■ Two more cost categories are often used in discussions of manufacturing cosprime cost and conversion cost. ■ 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. ● term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product. D. EX: consider the following scenario: A company has reported the following costs and expenses for the most recent month: categorized in a number of ways, including product costs, period costs, conversion costs, and prime costs: IV. Cost Classifications for Predicting Cost Behavior A. often necessary to predict how a certain cost will behave in response to a change in activity. ■ example, a manager at Under Armour may want to estimate the impact a 5 percent increase in sales would have on the company’s total direct materials cost. B. Cost behavior refers to how a cost reacts to changes in the level of activity. ■ As the activity level rises and falls, a particular cost may rise and fall as well—or it may remain constant. ■ the manager must be able to estimate how much it will change ■ To help make such distinctions, costs are often categorizedvariable, fixe ormixed. C. The relative proportion of each type of cost in an organization is known acost structure ■ For example, an organization might have many fixed costs but few variable or mixed costs. Alternatively, it might have many variable costs but few fixed or mixed costs. D. Variable Cost ■ A variable cost varies, in total, in direct proportion to changes in the level of activity. ● EX: cost of goods sold for a merchandising company, direct materials, direct labor, variable elements of manufacturing overhead, such as indirect materials, supplies, and power, and variable elements of selling and administrative expenses, such as commissions and shipping costs ■ cost to be variable, it must be variwith respect to something. That “something” is its activity base. ● An activity base is a measure of whatever causes the incurrence of a variable cost. ● An activity base is sometimes referred to acost driver. ○ most common activity bases are direct laborhours, machinehours, units produced, and units sold. ○ Other examples: the number of miles driven by salespersons, the number of pounds of laundry cleaned by a hotel, the number of calls handled by technical support staff at a software company, and the number of beds occupied in a hospital. ○ you should assume that the activity base under consideration is the total volume of goods and services provided by the organization. → We will specify the activity base only when it is something other than total output. ○ provide an example of a variable cost, consider Nooksack Expeditions, a small company that provides daylong whitewater rafting excursions on rivers in the North Cascade Mountains. (a) company provides all of the necessary equipment and experienced guides, and it serves gourmet meals to its guests. (b) meals are purchased from a caterer for $30 a person for a daylong excursion. The behavior of this variable cost, on both a per unit and a total basis, is shown below: (c) \ ■ total variable costs change as the activity level changes, it is important to note that a variable cost is constant if expressed on aper unitasis. ● EX: the per unit cost of the meals remains constant at $30 even though the total cost of the meals increases and decreases with activity. ● Exhibit 2–2 illustrates that the total variable cost rises and falls as the activity level rises and falls. ○ At an activity level of 250 guests, the total meal cost is $7,500. At an activity level of 1,000 guests, the total meal cost rises to $30,000. ○ E. Fixed Cost ■ A fixed cost is a cost that remains constant, in total, regardless of changes in the level of activity. ● EX: straightline depreciation, insurance, property taxes, rent, supervisory salaries, administrative salaries, and advertising. ■ Consequently, as the activity level rises and falls, total fixed costs remain constant unless influenced by some outside force, such as a landlord increasing your monthly rental expense. ■ To continue the Nooksack Expeditions example, assume the company rents a building for $500 per month to store its equipment. ● The total amount of rent paid is the same regardless of the number of guests the company takes on its expeditions during any given month. The concept of a fixed cost is shown graphically on the righthand side Exhibit 2–2. ■ Because total fixed costs remain constant for large variations in the level of activity, the average fixed costper uni becomes progressively smaller as the level of activity increases. ● Note that as the number of guests increase, the average fixed cost per guest drops. ● ■ For planning purposes, fixed costs can be viewed as eicommitted ordiscretionary. ● Committed fixed costs represent organizational investments witmulti yea planning horizon that can’t be significantly reduced even for short periods of time without making fundamental changes. ○ EX: investments in facilities and equipment, as well as real estate taxes, insurance expenses, and salaries of top management. ○ committed fixed costs remain largely unchanged in the short term because the costs of restoring them later are likely to be far greater than any shortrun savings that might be realized ● Discretionary fixed costs (often referred tomanaged fixed costs) usually arise from annual decisions by management to spend on certain fixed cost items. ○ EX: discretionary fixed costs include advertising, research, public relations, management development programs, and internships for students. ○ Discretionary fixed costs can be cut for short periods of time with minimal damage to the longrun goals of the organization. F. The Linearity Assumption and the Relevant Range ■ Management accountants ordinarily assume that costs are strictly linear; that is, the relation between cost on the one hand and activity on the other can be represented by a straight line. ■ Economists point out that many costs are actually curvilinear; that is, the relation between cost and activity is a curve. ■ Nevertheless, even if a cost is not strictly linear, it can be approximated within a narrow band of activity known as televant range by a straight line. ● The relevant range is the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid. ● Outside of the relevant range, a fixed cost may no longer be strictly fixed or a variable cost may not be strictly variable ● assumptions made about cost behavior may be invalid if activity falls outside of the relevant range. ● The concept of the relevant range is important in understanding fixed costs. ● Blood tests example: ■ This steporiented cost behavior pattern can also be used to describe other costs, such as some labor costs. ● For example, salaried employee expenses can be characterized using a step pattern. ● Salaries are fixed amount every year, providing for capacity to work a prespecified amount of time, such as 40 hours a week for 50 weeks a year =2,000 hours per year. ○ In this example, the total salaried employee expense is $40,000 within a relevant range of 0 to 2,000 hours of work. The total salaried employee expense increases to $80,000 (or two employees) if the organization’s work requirements expand to a relevant range of 2,001 to 4,000 hours of work. ○ Cost behavior patterns such as salaried employees are often called stepvariable costs. ○ Stepvariable costs can often be adjusted quickly as conditions change. ○ the width of the steps for stepvariable costs is generally so narrow that these costs can be treated essentially as variable costs for most purposes. The width of the steps for fixed costs, on the other hand, is so wide that these costs should be treated as entirely fixed within the relevant range. ○ Exhibit 2–4 summarizes four key concepts related to variable and fixed costs. Study it carefully before reading further. G. Mixed Costs ■ A mixed cost contains both variable and fixed cost elements. Also known as semivariable costs. ■ EX cont: the company incurs a mixed cost called fees paid to the state. It includes a license fee of $25,000 per year plus $3 per rafting party paid to the state’s Department of Natural Resources. If the company runs 1,000 rafting parties this year, then the total fees paid to the state would be $28,000, made up of $25,000 in fixed cost plus $3,000 in variable cost. ● Exhibit 2–5 depicts the behavior of this mixed cosT ● Even if Nooksack fails to attract any customers, the company will still have to pay the license fee of $25,000. This is why cost line in 25 intersects the vercial cost at $25,000. For each rafting party, the total cost of state fees will increase by $3→ the total cost line slopes upward as variable cost of $3 per party is added to the fixed cost of $25,000 ● Because the mixed cost in Exhibit 2–5 is represented by a straight line, the following equation for a straight line can be used to express the relationship between a mixed cost and the level of activity: ● Because the variable cost per unit = the slope of the straight line, the steeper the slope, the higher the variable cost per unit. ● The equation: ● Equation makes it easy to calc the total mixed cost for any level of activity wihtin the relevant range ○ EX: suppose company expects to organize 800 rafting parties in next year. Total state fees would be: H. Analysis of Mixed Costs ■ Mixed costs are very common. ■ The fixed portion of a mixed cost represents the minimum cost of having a servready and available for use. The variable portion represents the cost incurreactual consumption of the service, thus it varies in proportion to the amount of service actually consumed. ■ Managers can use a variety of methods to estimate the fixed and variable components of a mixed cost such asaccount analysis, the engineering approach, thehighlow method, and leastsquares regression analysis. ● Inaccount analysis, an account is classified as either variable or fixed based on the analyst’s prior knowledge of how the cost in the account behaves. ○ example, direct materials would be classified as variable and a building lease cost would be classified as fixed because of the nature of those costs. ● The engineering approach to cost analysis 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. ■ Diagnosing Cost Behavior with a Scattergraph Plot ● COME BACK TO IT ■ The Highlow Method ● Assuming that the scattergraph plot indicates a linear relation between cost and activity, the fixed and variable cost elements of a mixed cost can be estimated using thighlow method or theleastsquares regression method. ○ The highlow method is based on the riseoverrun formula for the slope of a straight line ○ slope of the straight line is equal to the variable cost per unit of activity ● To analyze mixed costs with the highlow method , begin by identifying the period with the lowest level of activity and the period with the highest level of activity. ○ The period with the lowest activity is selected as the first point in the above formula and the period with the highest activity is selected as the second point. ○ Consequently, the formula becomes: ○ OR ○ Therefore, when the highlow method is used, the variable cost is estimated by dividing the difference in cost between the high and low levels of activity by the change in activity between those two points. ○ To return to the Brentline Hospital example, using the highlow method, we first identify the periods with the highest and lowestactivit—in this case, June and March. We then use the activity and cost data from these two periods to estimate the variable cost component as follows: ● Having determined that the variable maintenance cost is 80 cents per patientday, we can now determine the amount of fixed cost. This is done by taking the total cost aeither the high or the low activity level and deducting the variable cost element. In the computation below, total cost at the high activity level is used in computing the fixed cost element: ● Both the variable and fixed cost elements have now been isolated. The cost of maintenance can be expressed as $3,400 per month plus 80 cents per patientday or as: ● The data used in this illustration are shown gxhibit 2– that is what the highlow method does—it draws a straight line through those two points. ● COME BACK TO ■ The Leastsquares regression Method ● The leastsquares regression meth, unlike the highlow method, uses all of the data to separate a mixed cost into its fixed and variable components. ● A egression li of the fr= +bX is fitted to the dataa represents the total fixed cost ab represents the variable cost per unit of activity. ● The basic idea underlying the leastsquares regression method iExhibit 2–8 d in using hypothetical data points. ● COME BACK ● COME BACK ■ The Contribution Format Income Statement ● COME BACK I. Traditional Contribution Format IS ■ The traditional format IS ■ The Contribution Formal IS ● The crucial distinction between fixed and variable costs is at the heart of the contribution approach to constructing income statements. The unique thing about the contribution approach is that it provides managers with an income statement that clearly distinguishes between fixed and variable costs and therefore aids planning, controlling, and decision making. The righthand side of Exhibit 2–9 shows a contribution format income statement for merchandising companies. ● The contribution approach separates costs into fixed and variable categories, first deducting variable expenses from sales to obtain thecontribution margin. For a merchandising company, cost of goods sold is a variable cost that gets included in the “Variable expenses” portion of the contribution format income statement. The contribution margin is the amount remaining from sales revenues after variable expenses have been deducted. This amount contributes toward covering fixed expenses and then toward profits for the period. J. Cost Classifications for Decision making ■ Differential Cost and Revenue ● Decisions involve choosing between alternatives. In business decisions, each alternative will have costs and benefits that must be compared to the costs and benefits of the other available alternatives ● A difference in costs between any two alternatives is known differential cos. ● A difference in revenues (usually just sales) between any two alternatives is known as differential revenue ● A differential cost is also known aincremental cost , although technically an incremental cost should refer only to an increase in cost from one alternative to another; decreases in cost should be referred to decremental costs. ○ Differential cost is a broader term, encompassing both cost increases (incremental costs) and cost decreases (decremental costs) between alternatives. ● The accountant’s differential cost concept can be compared to the economist’s marginal cost concept. ○ In speaking of changes in cost and revenue, the economist uses the terms marginal cost and arginal revenue. ○ The revenue that can be obtained from selling one more unit of product is called marginal revenue, and the cost involved in producing one more unit of product is called marginal cost. ○ The economist’s marginal concept is basically the same as the accountant’s differential concept applied to a single unit of output. ● COME BACK K. Opportunity Cost and Sunk Cost ■ Opportunity cost is the potential benefit that is given up when one alternative is selected over another. ● For example, assume that you have a parttime job while attending college that pays $200 per week. If you spend one week at the beach during spring break without pay, then the $200 in lost wages would be an opportunity cost of taking the week off to be at the beach. ■ A unk cost is a costhat has already been incurred and that cannot be changed by any decision made now or in the future. ● Because sunk costs cannot be changed by any decision, they are not differential costs. And because only differential costs are relevant in a decision, sunk costs should always be ignored. ● COME BAC ●
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'