MANAGERIAL ACCOUNTING

COST BEHAVIORS, SYSTEMS, AND ANALYSIS

with Gary Hecht

Costing Systems 1:
Elements and Design

Financial Perspective and Costing

System Approaches

Lesson Objectives

LESSON 2-1 OBJECTIVES

You will understand:

The purpose of costing systems inside
organizations
How to identify different types of costing
systems

Flow of Costs Through Financial Statements

FUNDAMENTALS

Financial perspective
Product costing according to generally
accepted accounting principles
Matching principle
Inventoriable costs versus period costs

Costs versus expenses

DIFFERENT PERSPECTIVES OF COSTS:

MANUFACTURING SETTING
PRODUCT COSTS
=
INVENTORIABLE
COSTS

DIRECT
PRODUCT
COSTS

PERIOD COSTS
=
SELLING & ADMIN

INDIRECT
PRODUCT COSTS
=
MFG OVERHEAD

FLOW OF COSTS THROUGH

FINANCIAL STATEMENTS
Direct
Materials
Direct
Labor
Mfg
Overhead

Work in
Process
Inventory

Finished
Goods
Inventory

Cost of
Goods
Sold

Two Traditional Systems

COST SYSTEMS BY COST

OBJECT TYPE
Many types of costing systems - one
distinction relates to cost object type
Job Costing
Cost object is a unit or multiple units of a
distinct product or service
Process Costing
Cost object is masses of identical or
similar units of product or service

Often, a continuum . . .

EXAMPLES
Job costing
Law firms
Consulting
Planes, yachts

Process costing
Computers
Food products
Mail, express delivery

JOB COSTING VS. PROCESS COSTING

Job Costing: Accumulates Costs by Individual Job

Work-inProcess
Inventory
Job 1
Direct Material
Direct Labor
Manufacturing Overhead

Job 2
Job 3

FinishedGoods
Inventory

Cost of
Goods
Sold

JOB COSTING VS. PROCESS COSTING

Process Costing: Accumulates Costs by Production Department
Direct Material
Direct Labor
Manufacturing Overhead

Work-in-Process Inventory:
Production Department A

Work-in-Process Inventory:
Production Department B

Finished-Goods Inventory

Cost of Goods Sold

Extension Overhead Costs

OVERHEAD CONSIDERATIONS

Consulting firm setting

Accounting for costs
Pricing decision

Two general types of costs

Labor
Overhead

OVERHEAD TIMING

Beginning
of the
Period

Decisions

Budgeted

End
of the
Period

Applied

Actual

APPLYING OVERHEAD

A simple formula:
Predetermined OH Rate = Budgeted Overhead (Total)
Total Volume of Driver

Use this rate to allocate overhead.

EXAMPLE
Step 1: Calculate Rate
Predetermined OH Rate = Budgeted Overhead (Total)
Total Volume of Driver
Predetermined OH Rate =

$1,500,000
30,000 Labor Hours

$50 per hour

EXAMPLE

Step 2: Apply Overhead

Suppose a consulting engagement used 350 labor hours.
$50 per hour x 350 hours = $17,500

CORRECTING ESTIMATES
The predetermined OH rate is based
on budgeted information.
However, estimates from the
beginning of the year likely do not
match actual overhead at the end of
the year.
An adjustment is usually made to
reflect this difference in the costing
system.

VIDEO 2-1.6

What Weve Learned

What Weve Learned

WHAT WEVE LEARNED

IN LESSON 2-1
Financial perspective of costs
How costs flow through financial statements
Production costs remain in inventory
(i.e., as an asset) until sold

Various types of costing systems

Adopted by organizations according to
nature of business and product

The Problem of Fixed Costs

Lesson Objectives

LESSON 2-2 OBJECTIVES

You will understand:

How to account for costs using
absorption costing, which is required for
financial reporting purposes
The problems associated with fixed costs
for decision making

Example Scenario

MANUFACTURING SETTING
Financial Accounting
Revenue
-

Direct Material (V)

Direct Labor (V)

Overhead (V & F)

Gross Margin

Other Expenses (V & F)

Profit

EXAMPLE
Keith Adventures, Inc. manufactures and sells a variety of boats and jet skis. The
following information is available for its main line of boats.
Selling price (per unit)
$ 21,000


Variable costs (per unit)

Materials
5,000
Labor
3,000
Selling
2,000


Fixed costs (total)

Manufacturing
1,500,000
Selling
450,000

Month 1



Beginning inventory
0


ProducFon
400


Sales
300


Ending inventory
100

Month 2


100

350

400

50

CREATING THE INCOME STATEMENT

What is Keiths revenue from boats for Month 1?
$21,000 per unit x 300 units sold = $6,300,000

What are Keiths variable manufacturing costs?

Direct materials + Direct labor = $5,000 + $3,000 = $8,000 per unit
Total = $8,000 per unit x 400 units = $3,200,000

Where are the variable manufacturing costs reported?

Income statement (COGS): $8,000 x 300 units sold = $2,400,000
Balance sheet (Inventory): $8,000 x 100 units in inventory = $800,000

CREATING THE INCOME STATEMENT (CONT)

What are Keiths fixed manufacturing costs for Month 1?

Given as $1,500,000

Where are the fixed manufacturing costs reported?

How much fixed cost is allocated per unit?
$1,500,000 / 400 units produced = $3,750 per unit
Income statement (COGS): $3,750 x 300 units sold = $1,125,000
Balance sheet (Inventory): $3,750 x 100 units in inventory = $375,000

CREATING THE INCOME STATEMENT (CONT)

What are Keiths other costs?

Variable selling and admin: $2,000 per unit x 300 units sold = $600,000
Fixed selling and admin: $450,000

Where are these costs reported?

All on the income statement, as they are not inventoriable costs

INCOME STATEMENT MONTH 1

Revenues

$6,300,000

Cost of goods sold

3,525,000

Gross margin

2,775,000

Total Selling & Admin

1,050,000

Operating income

1,725,000

2,400,000 + 1,125,000

600,000 + 450,000

The Manager Did What?

AN ALTERNATIVE
VERSION
Lets envision a different version
of Month 1 . . .
That is, suppose that Keith
manufactured 800 units (instead
of the 400 units in our original
scenario).

ALTERNATIVE VERSION
What is Keiths revenue from boats for Month 1?
$21,000 per unit x 300 units sold = $6,300,000

What are Keiths variable manufacturing costs?

Direct materials + Direct labor = $5,000 + $3,000 = $8,000 per unit
Total = $8,000 per unit x 800 units = $6,400,000

Where are the variable manufacturing costs reported?

Income statement (COGS): $8,000 x 300 units sold = $2,400,000
Balance sheet (Inventory): $8,000 x 500 units in inventory = $4,000,000

ALTERNATIVE VERSION (CONT)

What are Keiths fixed manufacturing costs for Month 1?

Given as $1,500,000

Where are the fixed manufacturing costs reported?

How much fixed cost is allocated per unit?
$1,500,000 / 800 units produced = $1,875 per unit
Income statement (COGS): $1,875 x 300 units sold = $562,500
Balance sheet (Inventory): $1,875 x 500 units in inventory = $937,500

COMPARISON

400 units

800 units

$6,300,000

$6,300,000

Cost of goods sold

3,525,000

2,962,500

Gross margin

2,775,000

3,337,500

Total Selling & Admin

1,050,000

1,050,000

Operating income

1,725,000

2,287,500

Revenues

INCENTIVE IMPLICATIONS
Assume the boating business unit managers evaluation and
compensation is determined by operating income . . .
Certainly, the manager is aligned with the organization.
However, the accounting story might induce inventory build-up!

WHAT IS THE ROOT OF

THE PROBLEM?
Accounting for fixed costs is
complicated.
Absorption costing (required for
financial accounting purposes)
treats fixed costs as product costs.
Financial accounting information
may not be the best for internal
decision-making.

POTENTIAL FIX?
For internal purposes, firms can
account for costs however they
like.
Variable costing is one such
method.
Separate costs according to
behavior, and account for variable
costs on a per unit basis, and leave
fixed costs in aggregate.

What Weve Learned

WHAT WEVE LEARNED

IN LESSON 2-2
Challenges of accounting for
fixed costs
Misleading information
Dysfunctional behavior

Customization of information
according to decision

WHAT WEVE LEARNED

IN MODULE 2
The purpose of costing systems
How to differentiate the financial and
managerial perspectives of costing
systems
Different types of costing systems
The problems associated with
accounting for fixed costs