CHAPTER 2:

BASIC MANAGERIAL
ACCOUNTING CONCEPTS
Basic Concepts:
The Meaning and Uses of Cost
 Determine the cost of products, services,
customers, and other items to managers.
 Cost is the amount of cash or cash equivalent
sacrificed for goods and/or services that bring a
current or future benefit to the organization.

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The Meaning and Uses of Cost (cont.)
 As costs are used up in the production of
revenues do expire.
 Expired costs are called expenses.
 The revenue per unit is called price.

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Cost Objects
 Managerial accounting systems are structured to
measure and assign costs.
 A cost object is any item such as a product,
customer, department, project, geographic
region, plant, and so on, for which costs are
measured and assigned.

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Direct and Indirect Costs
 Direct costs are costs that can be easily and
accurately traced to a cost object.
 When a cost is easy to trace, we mean that the
relationship between the cost and the object can
be physically observed, is easy to track, and
results in more accurate cost assignments.

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Direct and Indirect Costs (cont.)
 Indirect costs are costs that cannot be easily
and accurately traced to a cost object.
 Some businesses refer to indirect costs as
overhead costs or support costs.

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Other Categories of Cost
 Costs can be direct or indirect, and are analyzed
by their behavior patterns, or the way in which a
cost changes when the level of the output
changes.
 Variable cost: A variable cost is one that increases in
total as output increases and decreases in total as
output decreases.

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Other Categories of Cost (cont.)
 Fixed cost: A fixed cost is a cost that does not increase
in total as output increases and does not decrease in
total as output decreases.
 Opportunity cost: An opportunity cost is the benefit
given up or sacrificed when one alternative is chosen
over another.

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Product Costs
 Output is one of the most important cost objects.
 There are two types of output: products and
services.
 Products are goods produced by converting raw
materials through the use of labor and indirect
manufacturing resources, such as the
manufacturing plant, land, and machinery.
 Televisions, hamburgers, automobiles, computers,
clothes, and furniture are examples of products.

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Service Costs
 Services are tasks or activities performed for a
customer or an activity performed using an
organization’s products or facilities.
 Insurance coverage, medical care, dental care, funeral
care, and accounting are examples of service activities.
 Car rental, video rental, and skiing are examples of
services where the customer uses an organization’s
products or facilities.

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Determining Product Cost
 Product (manufacturing) costs are costs, both
direct and indirect, of producing a product in a
manufacturing firm or of acquiring a product in a
merchandising firm and preparing it for sale.
 Only costs in the production section of the value chain
are included in product costs.

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Direct Materials
 Direct materials are materials that are a part of
the final product and can be directly traced to the
goods being produced.
 The materials cost can be directly charged to
products because physical observation can be
used to measure the quantity used by each
product.
 Materials that become part of a product usually
are classified as direct materials.

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Direct Labor
 Direct labor is the labor that can be directly
traced to the goods being produced.
 Physical observation can be used to measure the
amount of labor used to produce a product.
 Those employees who convert direct materials into a
product are classified as direct labor.
 A company can also have indirect labor costs.
 Indirect labor is included in overhead and, therefore, is
an indirect cost rather than a direct cost.

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Manufacturing Overhead
 All product costs other than direct materials and
direct labor are considered manufacturing
overhead.
 Manufacturing overhead also is known as factory
burden or indirect manufacturing costs.

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Manufacturing Overhead (cont.)
 Costs are included as manufacturing overhead if
they cannot be traced to the cost object of
interest (e.g., unit of product).
 Manufacturing overhead cost category includes a
variety of items.
 Examples include depreciation on plant buildings and
equipment, janitorial and maintenance labor, plant
supervision, materials handling, power for plant utilities,
and plant property taxes.

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Prime and Conversion Costs
 Product costs of direct materials, direct labor, and
manufacturing overhead can be grouped into
prime cost and conversion cost:
 Prime cost is the sum of direct materials cost and direct
labor cost.
 Prime cost = Direct materials + Direct labor

 Conversion cost is the sum of direct labor cost and

manufacturing overhead cost.

Conversion cost = Direct labor + Manufacturing Overhead

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Period Costs
 Costs of production are assets that are carried in
inventories until the goods are sold.
 Other costs, such as period costs, are not
carried in inventory.
 Period costs are all costs that are not product costs (i.e.,
all areas of the value chain except for production).

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Period Costs (cont.)
 Examples of period costs: Office supplies, research
and development activities, the CEO’s salary, and
advertising.
 The level of period costs can be significant and
controlling them may bring greater cost savings than the
same effort exercised in controlling production costs.

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Selling Costs
 Those costs necessary to market, distribute, and
service a product or service are selling costs.
Order-
getting EXAMPLES
Sales personnel
Salaries &
Commissions
Advertising
EXAMPLES
Warehousing Order-
Shipping
Customer Filling
Service

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Administrative Costs
 Administrative costs include research,
development, and general administration of the
organization and cannot be assigned to either
selling or production.
 General administration ensures that the various
activities of the organization are integrated so that
the overall mission of the firm is realized.

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Administrative Costs (cont.)
 Examples of general administrative costs are: Executive
salaries, legal fees, printing the annual report, and
general accounting.
 Research and development costs include: Designing
and developing new products and must be expensed in
the period incurred.

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Preparing Income Statements:
Cost of Goods Manufactured
 The cost of goods manufactured represents the
total product cost of goods completed during the
current period and transferred to finished goods
inventory.
 The cost of direct materials used in production
can be derived using the following formula:

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Preparing Income Statements:
Cost of Goods Manufactured
 The direct materials used is then used to
calculate the cost of goods manufactured as
follows:

+ Direct materials
+ Direct labor
+ Manufacturing overhead costs
+ Beginning WIP inventory
- Ending WIP inventory
= Cost of goods manufactured

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Cost of Goods Sold
 To meet external reporting requirements, costs
must be classified into three categories:
 Production
 Selling
 Administration

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Cost of Goods Sold (cont.)
 Cost of goods sold represents the cost of goods
that were sold during the period and then
transferred from finished goods inventory on the
balance sheet to cost of goods sold on the
income statement (i.e., as an inventory expense).
Cost of goods sold is calculated as:
+ Beginning finished goods inventory
+ Cost of goods manufactured
- Ending finished goods inventory
= Cost of goods sold
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Income Statement: Manufacturing
Firm
 All sales revenue and expenses attached to a
time period are on the income statement.
 The heading of the financial statement tells us
what type of statement it is – Income Statement;
for what firm- the name of the company; and for
what period.
 Sales revenue is calculated as:

Sales revenue = Price x Units sold

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Income Statement: Manufacturing
Firm
 Gross margin is the difference between sales
revenue and cost of goods sold:
Sales Revenue
– Cost of Goods Sold
= Gross Margin
 It shows how much the firm is making over and above
the cost of the units sold.

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Income Statement: Manufacturing
Firm (cont.)
 Gross margin does not equal operating income or profit
as it is computed without subtracting selling and
administrative expenses.
 If gross margin is positive, the firm is charging prices
that cover the product cost.

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Operating Income
 Selling and administrative expenses for the
period are subtracted from gross margin to arrive
at operating income.
Gross Margin - Selling and Administrative
Expenses = Operating Income
 Operating income is the key figure from the
income statement
 It shows how much the owners are actually earning
(profit) from the company.

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Format of Cost of Goods
Manufactured Report:

Chapter 2 - Basic Managment Accounting Concepts

Chapter 2 - Basic Managment Accounting Concepts
Chapter 2 - Basic Managment Accounting Concepts
Chapter 2 - Basic Managment Accounting Concepts