1 Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Mowen/Hansen Basic Managerial Accounting Concepts Chapter Two Cornerstones of Managerial Accounting 2e

2 Cost Let’s look at an example Amount of cash or cash equivalent sacrificed for goods and/or services Expected to bring a current or future benefit to the organization

3 A wood furniture manufacturer buys lumber for $10,000. Cost of the lumber is the amount given up…. $10,000 Example

4 Expenses As costs are used up in the production of revenues, they are said to expire. Expired costs are called EXPENSES

5 Cost vs. Price Be careful! Cost & Price are not the same thing Cost Price Amount we charge our customers for our products or services What we pay for something

6 Accumulating Costs Telephone Expense Received Telephone bill + $150 Recorded in Telephone Expense account Bal. $800 $950 $150 Phone Bill

7 Accumulating Costs Telephone Expense + $150 Bal. $800 $950 This is helpful but managers also need to know which departments used the $950 in Telephone Expense In other words, managers want to know how costs are assigned to cost objects.

8 Cost Objects Let’s continue with our example Any item for which costs are measured and assigned Examples: ◦Products ◦Customers ◦Departments ◦Regions

9 Assigning Costs Let’s say the Telephone Expense was incurred by the Sales and the Manufacturing Departments The Sales and Manufacturing departments are the cost objects Sales Dept. Manufacturing Dept.

10 Assigning Costs Telephone Expense + $150 Bal. $800 $950 Sales Dept. $350 $600 Manufacturing Dept. The accountant assigned the Telephone Expense to the two cost objects.

11 Assigning Costs These methods will be discussed in the succeeding chapters. Costs can be assigned in a number of ways Some methods are more accurate, but time consuming While others are quite simple but not as precise

12 Direct Costs Costs that can be easily and accurately traced to a cost object Relationship between the cost and the object can be physically observed

13 Indirect Costs Costs that cannot be easily traced to a cost object Relationship between the cost and the object not easily observed Assigned through allocation

14 Other Categories of Cost Variable Cost = Increases in total as output increases and decreases in total as output decreases Fixed Cost = Total does not increase as output increases and does not decrease as output decreases

15 Benefit given up or sacrificed when one alternative is chosen over another Other Categories of Cost Opportunity Cost

16 One of the most important cost objects of a company is its output. Two types of output: Tangible Products Services Output

17 Goods produced by converting raw materials through the use of labor and capital inputs. Produced by manufacturing organizations. Tangible Products

18 Tasks or activities performed for a customer or an activity performed by a customer using an organization’s products or facilities. Produced by service organizations. Services

19 Cost Types Product costs Associated with the manufacture of goods or the provision of services Nonproduction costs All other costs

20 Examples: Nonproduction Costs General Administration Designing Developing Distribution Customer Service Marketing

21 Examples: Nonproduction Costs Distribution Customer Service Marketing These are Selling Costs

22 Examples: Nonproduction Costs General Administration Designing Developing These are Administrative Costs

23 Only three cost elements can be assigned to products for financial reporting: Direct Materials Direct Labor Overhead Product Cost Classifications

24 Direct Materials Materials that are a part of the final product and can be directly traced to the goods and services being produced.

25 Direct Labor Labor that can be directly traced to the goods or services being produced.

26 Overhead All product costs other than direct materials or direct labor. Supplies Utilities Indirect Materials Indirect Labor

27 Total Product Cost Direct Materials + Direct Labor Overhead + Total Product Cost =

28 Total Product Cost Unit Cost Number of Units Produced = Let’s work through an example Product Cost Per Unit

29 Conversion Costs Direct Labor + Overhead It is the cost of converting raw materials into a final product.

30 Period Costs Unlike product costs which are carried in inventory; period costs are expensed in the period in which they are incurred. Two categories of period costs: Selling Costs and Administrative Costs.

31 Costs necessary to market, distribute, and service a product or service. Examples: Salaries and commissions of sales people Advertising Warehousing Shipping Customer Service Selling Costs

32 All costs associated with research, development, and general administration of the organization that cannot reasonably be assigned to either selling or production. Examples: General Accounting Top Executive Salaries Legal Fees Expenses of printing the annual report Administrative Costs

33 Cost of Goods Manufactured + Overhead Direct Materials + Direct Labor Total product cost of goods completed during the current period Sounds simple enough. But there’s more to it than meets the eye.

34 Let’s go through an example. Direct Materials Used Only the amount used on products produced during the current period Consider beginning and ending inventory levels Key point: Purchases do not equal Materials Used

35 Work in Process Let’s continue our example Second type of inventory Cost of partially completed goods that are still on the factory floor at the end of the period Units are started, but not finished Included direct materials, direct labor, and overhead costs

36 “Sold” is the key word. Let’s continue with our example Cost of Goods Sold Represents the total cost of units sold during a period Includes only product cost Included direct materials, direct labor, and overhead Reported as an expense on the income statement

37 Income Statement: Service Organization Cost of services sold is typically made up of: ◦Materials ◦Labor ◦Overhead ◦No beginning or ending finished goods inventories. Cost of Services Sold will always equal Cost of Services Manufactured.