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Week 1- Cost Concepts

by: quincw

Week 1- Cost Concepts Acct 201

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Covers Chapter 1 manufacturing costs and nonmanufacturing costs, period and product costs, variable, fixed and mixed costs, contribution income statement, and differential, opportunity, and sunk c...
Intro-Accounting Mangerial
Minwoo Lee
Class Notes
Accounting, cost




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This 6 page Class Notes was uploaded by quincw on Saturday August 27, 2016. The Class Notes belongs to Acct 201 at Western Kentucky University taught by Minwoo Lee in Winter 2016. Since its upload, it has received 41 views. For similar materials see Intro-Accounting Mangerial in Accounting at Western Kentucky University.


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Date Created: 08/27/16
Prologue Managerial accounting provides information to managers for use within the organization Financial accounting serves needs outside the organization (external), whereas managerial does  inside needs (internal) Focuses on future decisions, relevance timeliness, and segment performance­revenue, cost and  profit data­ (product lines, customer groups etc.) whereas financial analyzes the past, is objective,  verifiable, precise, and company wide  Financial accounting is mandatory for external reports­ must comply with GAAP and managerial  accounting does not have to comply with any rules Helps planning (establish goals and how to achieve them), controlling (gathering feedback to  make sure plan is properly executed) and decision making (selecting a course of action from  alternatives) Planning­ must answer a lot of questions – establishing goals and objectives and deciding how they can  be achieved Develop a budget (detailed plan for future) Controlling­ gathering, evaluating, and responding to feedback Prepare a performance report­ compares budgeted data to actual data to rate performance Decision­making­ What, Who, and How? – selecting the best course of action Make decisions related to products sold, customers served, and how it is executed Helps people adapt to an uncertain future­ marketing, supply­chain management, and management IMA: Ethics of management accounting: maintain a high level of professional competence, treat sensitive  matters with confidentiality, maintain personal integrity, and disclose information in a credible fashion The focal point of company strategy should be its target customers­ game plan Customer value propositions­ customer intimacy (we meet your individual needs better than  others), operational excellence (faster, more convenient, and cheaper), and product leadership  (high quality products) Enterprise risk management­ evaluate strategy risk and develop responses to them Corporate social responsibility perspective­must balance stockholders and stakeholders Business process­ steps followed to carry out task in business Value chain­ adds value to cusomters and services Process management perspective­ lean production­ responds to customer orders Leadership perspective Cost object­ anything for which cost data is desired (ex. Products, customers, jobs) Direct cost­ cost that can be traced to a specific cost object Ex. The salary of a sales manager is a direct cost of an office, cost of papers used to make brochures for a customer is a direct cost to that customer Indirect cost­ cost that cannot be traced to a specific cost object Ex. In a company that produces soup, the salary of a manager would be an indirect cost  of one of the flavors of soup (it is a cost of running the whole factory) The cost of the manager salary is a common cost­ a cost that is incurred to  support a number of cost objects (types of soups) but cannot be traced to them  individually So the manager’s salary is an indirect cost of producing soup (cost object being soup), but it’s a  direct cost of the office (cost object being the office) Manufacturing companies have manufacturing and nonmanufacturing costs Manufacturing costs 1. Direct Materials (Direct cost) a. Raw materials­ materials that go into a final product (ex. Plastics in computers) i. Direct materials­ materials that become an important part of the finished  product, and the costs can be traced back to that (Ex. Electronic components  in IPhones) ii. Indirect materials­ materials that are really minor in the production of  products (Ex. Glue) [part of manufacturing overhead] 2. Direct Labor/Touch Labor (direct cost) a. Labor costs that can be traced to individual units of product (ex. Assembly line  workers at Toyota­ they actually touch the product) b. Indirect labor= cannot be traced to particular product [part of manufacturing  overhead] includes janitors, supervisors, etc. 3. Manufacturing Overhead (indirect cost) a. Includes ALL manufacturing costs except direct materials and direct labor b. Includes indirect materials, indirect labors, maintenance, taxes, insurance, electricity­ basically the costs associated with operating the factory Nonmanufacturing Costs 1. Selling Costs/Order­getting/Order­filling­ all costs that are incurred in order to secure  customer order and get the finished product out there a. Advertising, shipping, sales travel, sales commissions, sales salaries, cost of finished  good warehouses (can be indirect or direct) 2. Administrative Costs/Selling, General, and Administrative­ all costs associated with general  management of organization a. Salaries, accounting, public relation  administration of organization as a whole (can  be direct or indirect) Period costs vs Product Costs Costs are changed to expenses in the period that benefits from the cost The un­expensed portion = an asset Matching principle­ based on accrual concept that costs incurred to generate a particular Cost should change to expenses in the same period that revenue is recognized Product cost/Inventoriable Costs Cost recognized as expense when the benefit occurs All costs involved in acquiring or making a product Include direct materials, direct labor, and manufacturing overhead Product costs attach to each individual unit of production  Inventory on the balance sheet When they are sold they go under expenses as cost of goods sold RECORDED AS EXPENSES WHEN THE INDIVIDUAL PRODUCT IS SOLD Period Cost All the costs that are not product costs­ all selling and administrative expenses Not included as part of the cost in both purchased and manufactured goods Expensed on income statement in the period in which they are incurred (accrual) Prime Cost and Conversion Cost Prime cost­ sum of direct materials cost and direct labor cost Cost to make the product Conversion cost­ sum of direct labor cost and manufacturing overhead cost Cost to convert materials into the final product Ex. direct materials cost $69; direct labor costs $35, manufacturing overhead $14, selling  expenses $29, administrative expenses $50 Product Cost = Direct Materials + Direct Labor + Manufacturing Overhead = $69 + $35 + $14 Period Cost = Selling expenses + Administrative Expenses = $29 + $50 Conversion Cost = Direct Labor + Manufacturing Overhead = $35 + $14 Prime Cost = Direct Materials + Direct Labor = $69 + $35 Cost behavior­ how cost reacts to changes in the level of activity Costs are categorized as variable, fixed, or mixed Cost structure­ relative proportion of each type of cost in an organization Variable cost­ varies in direct proportion to changes in level of activity Ex. COGS, direct materials, direct labor, commissions, and shipping costs Must be variable w respect to activity base/cost driver (measures what causes the variable cost) –  direct labor hours, machine hours, units produced, and units sold, # of calls made Activity base = total volume of goods and services provided by organization (output) So adjusting food purchases relative to # of guests in the hotel The cost of the meal per guest remains the same, but the total cost varies based  on the number of guests The per unit cost remains constant Fixed cost­ cost that remains constant regardless of changes in level of activity Depreciation, insurance, tax, salaries, advertising­ not affected by change in activity Rent paid is the same regardless of the number of guests  Average fixed cost per unit decreases as activity increases 250 guests w $500 rent­ fixed rental cost = $2 avg per guest 1,000 guests w $500 rent­ fixed rental cost = $0.50 cents per guest As the number of guests increase, the average per unit fixed decreases Committed fixed costs­ organizational investments w multiyear planning horizon that cannot be  reduced  cannot be cut at all Investments in facilities, taxes, insurance expenses, salaries of top managers Discretionary/Managed fixed costs­ annual decisions by management to spend on certain fixed  cost items  can be cut for short periods of time  Advertising, research, public relations, internships Average fixed cost per unit is $5 at an activity level of 100 units­ total fixed cost = $500 If activity level increases, the total fixed cost still remains at $500 So more guests doesn’t mean that the rent is going to go up Relevant range­ range of activity within which the assumption that cost behavior is linear So for a fixed cost­ rent a machine for $20k that tests for $3000 a month The rent is only valid within 0 to 3000 tests If 3001 tests needed, then they have to rent another machine for $20k The fixed rent increases to $40k for 3001 to 6000 tests Rental expense increases in increments of 3000 tests­ step oriented Step­variable costs Salaried employees­ get paid salary regardless of how many hours they work in the range Therefore, if the work requirement expands, the paid salary expense must double Behavior of the Cost (within the relevant range) A variable cost  Cost In Total Per Unit increases in proportion  Variable Cost Total variable cost increases and Variable cost per unit remains  to activity (total cost of  meals increases with  COGS, labor  decreases in proportion to  constant number of guests) materials changes in activity level Fixed costs remain  Fixed cost Total fixed cost is not affected  Fixed cost per unit decreases as  constant in total dollar amount through wide  Depreciation  by changes in the activity level  the activity level rises and  ranges of activity  insurance  within the relevant range increases as the activity level  (rent remains the  same despite # of  taxes, rent falls Mixed/Semivariable cost­ contains both variable and fixed cost elements Ex. Fees paid to the state = $25k license fee + $3 per rafting party So, if there are 1,000 rafting parties total fees = $28,000 $28,000 = $25k (fixed cost) + $3 x $1000 (variable cost)   Still have to pay license fee even if no customer Cost 30k total cost line has slope of $3 of 29k Variable 28k y = a +bx State 27k Cosy = total mixed cost Licen 26k Elea = total fixed cost (intercept) se 25k b = variable cost (slope) Fee x = level of activity costrcept = total fixed Fixed Y = $25000 + $3x Cost 0 500 Mixed cost decreases (on a per unit basis) if  # of rafting parties Element Activity level increases because fixed portion is Being spread across more units Variable costs are constant if expressed on a per unit basis Total variable costs increase as the level of activity increases Three people go to a restaurant and each person orders a soda for $2, share a pizza for $12, and then  another person joins, buys a soda, and shares the pizza. IT IS NOT TRUE THAT the total cost of the pizza increased to $16 when the 4th person joined IT IS TRUE THAT the cost of their soda is $12, the total cost of sodas are $8, and the average  pizza cost per person dropped to $3 Cost of providing x­rays = mixed cost = variable cost (cost of X­ray film, power, supplies) + fixed cost  (cost of equipment depreciation, radiologist salary) Maintenance costs = mixed cost = fixed cost (rent facilities & salaries) + variable (replacement parts, oil,  tires) Fixed portion of a mixed cost = minimum cost of having a service available and ready to use Variable portion of a mixed cost = cost incurred for actual using the service (varies to how much is used) Account analysis: account is fixed or variable based on prior knowledge to how cost behaves Engineering approach: industrial engineer decides based on materials, labors, production, etc. High­low and least­square regression: analyze past records of cost and activity data 1. Create a scatter graph plot­ cost on Y­axis and activity on X­axis  make sure it is linear! 2.  High Low Method:  a. Select 2 periods w highest and lowest levels of activity b. variable cost = change in cost (high – low) / change in activity­ identify the highest  and lowest activity and subtract them c. fixed cost = total cost – variable cost element (high level – (variable cost x high  level) d. y = a + bx  total mixed cost for any level of activity in relevant range e. uses the cost at the highest and lowest levels of activity  3. Least Squares Regression Method a. Determined by a computer­ uses all data points to fit a line that minimizes the sum of  squared errors In months 1 and 2, a company's total selling expense was $64,000 and $80,000, respectively, at sales  volumes of 8,000 and 12,000 units, respectively. Using the high­low method, what is the company's  estimated selling expense in month 3 if it plans to sell 11,000 units? 80 – 64 / 12 – 8 = 4 (variable cost is $4) 80 – (4 x 12000) = 32000 (fixed cost) Y = 32000 + 4 x 11000  76,000 Y = total mixed cost; a = total fixed cost; b = variable cost per unit of activity; x = activity level Traditional income statement­ good for external, not so good for internal (no difference b/t fixed and  variable costs) Sales ­COGS [reports product costs attached to merchandiser sold] Gross Margin ­Selling and Administrative Expenses [period costs that are expensed as incurred] Net operating Income COGS = Beginning Merchandise Inventory + Purchases – Ending Merchandise Inventory Contribution Format Income Statement Distinguishes between fixed and variable costs Separates costs into fixed and variable catergories  Deducts variable expenses (including COGS) from sales to get contribution margin Contribution margin = amount remaining in sales revenue – variable expenses Amount contributes towards covering fixed expenses and then profits Emphasizes cost behavior which helps managers  Cost Classifications for Decision­Making Differential/Incremental cost­ difference in cost between any two alternatives Encompasses both cost increases and cost decreases  same as marginal cost  Difference between the present and proposed Only differences between alternatives matter­ those that are the same or are not  affected do not matter Differential revenue­ difference in revenue between any two alternatives Opportunity cost – the cost of the next best thing Sunk cost­ cost that has already been incurred and cannot be changed Not differential­ cannot be changed (IGNORE SUNK COSTS)


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