The Changing Role of Managerial Accounting in a GLOBAL Business Environment

BASIC COST MANAGEMENT CONCEPTS AND ACCOUNTING

FOR MASS CUSTOMIZATION OPERATIONS

Chapter 2Chapter 2

Learning Objectives • Explain the word "cost."• Distinguish among product costs, period costs, and expenses.• Describe the role of costs on published financial statements.• List five types of manufacturing operations and describe mass

customization.• Give examples of three types of manufacturing costs.• Prepare a schedule of cost of goods manufactured, a schedule of

cost of goods sold, and an income statement for a manufacturer.• Understand the importance of identifying an organization's cost

drivers.• Describe the behavior of variable and fixed costs, in total and on a

per-unit basis.• Distinguish among direct, indirect, controllable, and uncontrollable

costs.• Define and give examples of an opportunity cost, an out-of-pocket

cost, a sunk cost, a differential cost, a marginal cost, and an average cost.

Management ProcessesManagement Processes

DecisionMaking

DirectingControl

PlanningStrategy Formulation

Managers need cost information toperform each of these functions.

2-3

What Do We Mean By a Cost?

A costis the measure ofresources givenup to achieve a

particular purpose.

2-4

resources goals

Product Costs, Period Costs and Expenses

Product costs are costs associated with goods for sale until the time period during which the products are sold, at which time the costs become expenses.

Period costs are costs that are expensed during the time period in which they are incurred.

Expenses are the consumption of assets for the purpose of generating revenue.

2-5

Cost Classifications on Financial Cost Classifications on Financial Statements – Statements – Statement of Statement of Comprehensive IncomeComprehensive Income

Product CostsProduct Costs

Cost of goods sold

Period CostsPeriod Costs

Operating expenses

2-6

Cost Classifications on Financial Cost Classifications on Financial Statements – Statements – Statement of Financial Statement of Financial PositionPositionMerchandiser / TradingMerchandiser / Trading

Current Assets• Cash• Receivables• Prepaid Expenses• Merchandise InventoryMerchandise Inventory

ManufacturerManufacturer

Current Assets Cash Receivables Prepaid Expenses Inventories

Raw MaterialsRaw MaterialsWork in ProcessWork in ProcessFinished GoodsFinished Goods

2-7

Cost Classifications on Financial Cost Classifications on Financial Statements – Statements – Statement of Financial Statement of Financial PositionPosition MerchandiserMerchandiser


ManufacturerManufacturer

Current Assets CashCash ReceivablesReceivables Prepaid ExpensesPrepaid Expenses InventoriesInventories


Those materials waiting to be processed.

2-8

Cost Classifications on Financial Cost Classifications on Financial Statements – Statements – Statement of Financial Statement of Financial PositionPosition

MerchandiserMerchandiser


ManufacturerManufacturer Current Assets

CashCash ReceivablesReceivables Prepaid ExpensesPrepaid Expenses InventoriesInventories


Partially complete products – material to

which some labor and/or overhead has

been added.

2-9

Cost Classifications on Financial Cost Classifications on Financial Statements – Statements – Statement of Financial Statement of Financial PositionPosition

MerchandiserMerchandiser


ManufacturerManufacturer Current Assets

CashCash ReceivablesReceivables Prepaid ExpensesPrepaid Expenses InventoriesInventories


Completed products awaiting sale.

2-10

Types of Manufacturing Processes

Type of Production Description of Example ofProcess Process Manufacturer

Job Shop Low volume DisneyLittle standardization i.e. film

Unique products

Batch Multiple products CaterpillarLow volume i.e. heavy equipment

Assembly Line A few major products FordHigher volume i.e. automobile

Mass Customization High volume DellMany standardized components i.e. computer

Customized combination of components

Continuous Flow High volume ExxonHighly standardized commodity products i.e. gas

2-11

Manufacturing CostsManufacturing Costs

TheProduct

DirectLabor

Manufacturing Overhead

DirectMaterial

2-12

Direct MaterialDirect Material

Example:Steel used tomanufacture

the automobile.

Cost of raw material that is used tomake, and can be convenientlytraced, to the finished product.

2-13

Cost of salaries, wages, and fringebenefits for personnel who work

directly on manufactured products.

Direct LaborDirect Labor

Example:Wages paid to an

automobile assemblyworker.

2-14

Manufacturing OverheadManufacturing Overhead

All other manufacturing costs

Materials used to support the production process.

Examples: lubricants, glue and cleaning supplies used in an automobile assembly

plant.

IndirectLabor

IndirectMaterial

OtherCosts

2-15



Cost of personnel who do not work directly on

the product. Examples: maintenance workers, janitors and security guards in the factory

IndirectLabor

IndirectMaterial

OtherCosts

2-16



Examples: depreciation on plant and equipment,

property taxes, insurance, utilities,

overtime premium, and unavoidable idle time.

IndirectLabor

IndirectMaterial

OtherCosts

2-17

Manufacturing Cost FlowsManufacturing Cost Flows

ManufacturingOverhead

Direct Material

Direct Labor Work in Process Inventory

2-18



Direct Material

Direct Labor

FinishedGoods

Inventory

Work in Process Inventory

2-19



Direct Material

Direct Labor

FinishedGoods

Inventory

Cost of GoodsSold

Work in Process Inventory

2-20

Comet Computer CorporationSchedule of Cost of Goods Manufactured

Raw material used 134,980$ Direct labor 50,000 Total manufacturing overhead 230,000 Total manufacturing costs 414,980$ Add: Work-in-process inventory, January 1 120 Subtotal 415,100$ Deduct: Work-in-process inventory, December 31 100 Cost of goods manufactured 415,000$

Schedule of Cost of Goods Schedule of Cost of Goods ManufacturedManufactured

2-21




Computation of Cost of Raw Material Used

Raw-material inventory, January 1 6,000$ Add: Purchases of raw materials 134,000 Raw material available for use 140,000 Deduct: Raw material inventory, December 31 5,020 Raw material used 134,980$

2-22




Include all direct labor costs incurred during the

current period.

2-23



Computation of Total Manufacturing Overhead

Indirect material 10,000$ Indirect labor 40,000 Depreciation on factory 90,000 Depreciation on equipment 70,000 Utilities 15,000 Insurance 5,000 Total manufacturing overhead 230,000$

2-24




Beginning work-in-process inventory is carried over from the

prior period.

Ending work-in-process inventory contains the cost of unfinished goods, and is reported in the current assets section of the balance sheet.

2-25

Statement of Comprehensive Income Statement of Comprehensive Income for a Manufacturerfor a Manufacturer

2-26

Comet Computer CorporationSchedule of Cost of Goods Sold

For the Year Ended December 31, 20X2

Finished-goods inventory, Jan. 1 200$ Add: Cost of goods manufactured 415,000 Cost of goods available for sale 415,200 Deduct Finished-goods inventory, Dec. 31 190 Cost of goods sold 415,010$

Comet Computer CorporationIncome Statement

For the Year Ended December 31, 20X2Sales revenue 700,000$ Less: Cost of goods sold 415,010 Gross margin 284,990$ Selling and administrative expenses 174,490 Income before taxes 110,500$ Income tax expense 30,000 Net income 80,500$

2-27

Statement of Comprehensive Income Statement of Comprehensive Income for a Manufacturerfor a Manufacturer

Comet Computer CorporationIncome Statement

For the Year Ended December 31, 20X2Sales revenue 700,000$ Less: Cost of goods sold 415,010 Gross margin 284,990$ Selling and administrative expenses 174,490 Income before taxes 110,500$ Income tax expense 30,000 Net income 80,500$

Comet Computer CorporationSchedule of Cost of Goods Sold

For the Year Ended December 31, 20X2

Finished-goods inventory, Jan. 1 200$ Add: Cost of goods manufactured 415,000 Cost of goods available for sale 415,200 Deduct Finished-goods inventory, Dec. 31 190 Cost of goods sold 415,010$

2-28

Costs ClassificationsCosts Classifications- variable or fixed cost- variable or fixed cost- direct or indirect - direct or indirect - control or uncontrollable - control or uncontrollable

2-29

Cost ClassificationsCost Classifications

Cost behavior means how a cost will react to changes in the level of business activity.• Total variable costs change

when activity changes.

• Total fixed costs remain unchanged when activity changes.

2-30

Total Variable Cost ExampleTotal Variable Cost Example

Your total cable pay-per-view bill (ASTRO 1st) is based on how many movies you watch.

Pay-Per-View Movies Watched

Tota

l Pay

-Per

-Vie

w

Bill

2-31

Variable Cost Per Unit ExampleVariable Cost Per Unit Example

The cost per movie watched is constant. For example, $4.00 per movie.

Movies Watched

Per

Mov

ie C

harg

e

2-32

Total Fixed Cost ExampleTotal Fixed Cost Example Your monthly cable bill probably does not change when

you watch movies on channels that you have elected to be paid on a monthly basis (HBO).

Number of HBO Movies Watched

Mon

thly

Cha

rge

for

HB

O B

ill

2-33

Fixed Cost Per Unit ExampleFixed Cost Per Unit Example

The average cost per HBO movie decreases as more HBO movies are watched.

Number of HBO Movies Watched

Mon

thly

HB

O B

ill p

er M

ovie

W

atch

ed

2-34

Cost ClassificationsCost Classifications

Summary of Variable and Fixed Cost BehaviorCost In Total Per Unit

Total variable cost changes Variable cost per unitVariable as activity level changes. remains the same over

wide ranges of activity.

Total fixed cost remains Fixed cost per unitFixed the same even when the goes down as activity

activity level changes. level goes up.

2-35

Direct and Indirect CostsDirect and Indirect CostsDirect costs• Costs that can be

easily and conveniently traced to a product or department.

• Example: cost of paint in the paint department of an automobile assembly plant.

Indirect costs• Costs that must be

allocated in order to be assigned to a product or department.

• Example: cost of national advertising for an airline is indirect to a particular flight.

2-36

Controllable and Uncontrollable CostsControllable and Uncontrollable Costs

A cost that can be significantly influencedby a manager is a controllable cost.

Cost item Manager ClassificatonCost of food used Restaurant Controllablein a restaurant manager

Cost of national Restaurant Uncontrollableadvertising by a managerrestaurant chain

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Costs and Costs and Decision MakingDecision Making

2-38

Opportunity CostOpportunity Cost

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$20,000 per year. Your opportunity costof attending college for one year is $20,000.

2-39

Sunk CostsSunk Costs

All costs incurred in the past that cannot be changed by any decision made now or in the future are sunk costs. Sunk costs should not be considered in decisions.

• Example: You bought an automobile that cost $12,000 two years ago. The $12,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $12,000 cost.

2-40

Differential CostsDifferential Costs

Costs that differ between alternatives.

Example: You can earn $1,500 per month in yourhometown or $2,000 per month in a nearby city.

Your commuting costs are $50 per month in yourhometown and $300 per month to the city.

What is your differential cost? $300 - $50 = $250

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Marginal Costs and Average CostsMarginal Costs and Average Costs

The extra costincurred to produceone additional unit.

The total cost toproduce a quantity

divided by thequantity produced.

Marginal and average costs arelargely a function of cost behavior

-- variable and fixed costs.

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Costs and Benefits of InformationCosts and Benefits of Information

Costs Benefits

More information does not mean more benefits if information overload results.

2-43

ACTIVITY ANALYSIS, COST BEHAVIOR, AND COST

ESTIMATION

Chapter 6Chapter 6

Variable Cost

Fixed Cost

Semi-variable cost

Curvilinear cost

Cost BehaviorCost Behavior

6-45

Total Variable Cost ExampleTotal Variable Cost Example

Your total Pay Per View bill is based on how many Pay Per View shows that you watch.

Number of Pay Per View shows watched

Tota

l Pay

Per

Vie

w B

ill

6-46

Variable Cost Per Unit ExampleVariable Cost Per Unit ExampleThe cost per Pay Per View show is constant. For example,

$4.95 per show.

Number of Pay Per View shows watched

Cos

t per

Pay

Per

Vie

w

show

6-47

Step-Variable CostsStep-Variable Costs

Activity

Cos

t

Total cost remainsconstant within anarrow range of

activity.

6-48

Step-Variable CostsStep-Variable Costs

Activity

Cos

t

Total cost increases to a new higher cost for the next higher

range of activity. i.e. PT workers in hotel or dept store

6-49

Total Fixed Cost ExampleTotal Fixed Cost Example

Your monthly basic cable TV bill probably does not change no matter how many hours you watch.

Number of hours watched

Mon

thly

Bas

ic

Cab

le B

ill

6-50

Fixed Cost Per Unit ExampleFixed Cost Per Unit Example

The average cost per hour decreases as more hours are spent watching cable television.

Number of hours watched

Mon

thly

Bas

ic c

able

Bill

pe

r hou

r wat

ched

6-51

Step-Fixed CostsStep-Fixed Costs

Example: Office space is available at a rental rate of

$30,000 per year in increments of 1,000 square feet. As the business grows

more space is rented, increasing the total cost.

Continue

6-52

Ren

t Cos

t in

Thou

sand

s of

Dol

lars

0 1,000 2,000 3,000 Rented Area (Square Feet)

30

60

90

Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the

next higher range of activity.

Step-Fixed CostsStep-Fixed Costs

6-53

Semivariable CostSemivariable Cost

A semivariable cost is partly fixed

and partly variable.

Consider thefollowing example.

6-54

Fixed MonthlyUtility Charge

Variable Utility Charge

Activity (Kilowatt Hours)

Tota

l Util

ity C

ost

Total semivariable cost

Semivariable CostSemivariable Cost Slope is

variable costper unit

of activity.

6-55

Curvilinear CostCurvilinear CostCurvilinear

Cost Function

Relevant Range of company

activities

Activity

Tota

l Cos

tCurvilinear

Cost Function

A straight-Line(constant unit

variable cost) closely approximates a

curvilinear line withinthe relevant range.

6-56

Account-Classification Method

Visual-Fit Method

High-Low Method

Least-Squares Regression Method

Cost EstimationCost Estimation

6-57

Account Classification MethodAccount Classification Method

Cost estimates are based on areview of each account making up

the total cost being analyzed.6-58

Visual-Fit MethodVisual-Fit Method

A scatter diagram of past cost behavior may be helpful in analyzing mixed costs.

6-59

2) Draw a line through the plotted data points so that about equal numbers of points fall above and below the

line.


0 1 2 3 4

*

Tota

l Cos

t in

1,00

0’s

of D

olla

rs

10

20

0

***

**

* **

*

Activity, 1,000’s of Units Produced6-60

1) Plot the data points on a graph (total cost vs. activity).


Vertical distance is total cost,

approximately $16,000.

0 1 2 3 4

*

Tota

l Cos

t in

1,00

0’s

of D

olla

rs

10

20

0

***

**

* **

*

Activity, 1,000’s of Units Produced

Estimated fixed cost = $10,000

6-61

The High-Low MethodThe High-Low Method

OwlCo recorded the following production activity and maintenance costs for two months:

Using these two levels of activity, compute: the variable cost per unit. the total fixed cost.

Units CostHigh activity level 9,000 9,700$ Low activity level 5,000 6,100

6-62

Units CostHigh activity level 9,000 9,700$ Low activity level 5,000 6,100 Change 4,000 3,600$

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit


6-63

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit

Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)

Units CostHigh activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$


6-64

Units CostHigh activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$

Unit variable cost = $3,600 ÷ 4,000 units = $.90 per unit

Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($.90 per unit × 9,000 units) Fixed cost = $9,700 – $8,100 = $1,600


6-65

Least-Squares Regression MethodLeast-Squares Regression Method

Regression is a statistical procedure usedto determine the relationship between variables

such as activity and cost.

Activity

Tota

l Cos

t

The objective ofthe regressionmethod is the

general cost equation:Y = a + bX

6-66

Y = a + bX

Total Cost is thedependent variable.

The activity (X) is theindependent variable.

The X term coefficient (b)is the estimate of variablecost per unit of activity,

the slope of the cost line.

The intercept term (a) isthe estimate of fixed costs.

Equation Form of Least-Squares Equation Form of Least-Squares Regression LineRegression Line

6-67

Least-Squares Regression MethodLeast-Squares Regression Method

• Statistics courses and computer courses deal with detailed regression computations using computer spreadsheet software.

• Accountants and managers must be able to interpret and use regression estimates.

6-68

Terms in the equation have the samemeaning as in simple regression with

only one independent variable.

Multiple RegressionMultiple Regression

Multiple regression includes two or more independent variables:

Y = a + b1X1 + b2X2

6-69

Engineering MethodEngineering Methodof Cost Estimationof Cost Estimation

Cost estimates are based on measurement and pricing of the work involved.

6-70

Direct Labor

•Material requiredfor each unit isobtained from

engineering drawings and specification sheets.

•Material prices are determined from

vendor quotation.

•Analyze the kindof work performed.•Estimate the time

required for each labor skill for each unit.

•Use local wage rates to obtain labor cost

per unit.

Direct Material

Engineering MethodEngineering Methodof Cost Estimationof Cost Estimation

6-71

ExerciseMonths Machine hours Manufacturing overhead (RM)

May JuneJuly August

46,00060,00068,00052,000

889,0001,130,0001,274,000980,000

Manufacturing overhead consists of machine supplies, depreciation and plant maintenance. July’s manufacturing overhead costs were RM170,000 for machine supplies, RM24,000 for depreciation and RM1,080,000 for plant maintenance. Required: a)By using the high and low method, compute the monthly fixed portion and variable cost per machine hour. b)Determine the cost function.c)Compute the manufacturing overhead for September if 56,000 machine hours are worked.

Economy & Finance

The Changing Role of Managerial Accounting in a GLOBAL Business Environment