introduction to managerial accounting ch2.docx
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introduction to managerial accounting ch2.docx
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introductiontomanagerialaccountingch2
ManagerialCostConceptsandCostBehaviourAnalysis
ManufacturingCosts
●Manufacturingconsistsofactivitiestoconvertrawmaterialsintofinishedgoods.
●Incontrast,amerchandisingfirmsellsgoodsintheforminwhichtheywerebought.
Directmaterials
●Rawmaterialsarebasicmaterialsandpartsusedinmanufacturing.
●Rawmaterialsthatcanbephysicallyanddirectlyassociatedwiththefinishedproductarecalleddirectmaterials.
●Examplesinclude:
⏹Flourinthebakingofbread
⏹Syrupinthebottlingofsoftdrinks
⏹Steelusedinmakingautomobiles
Directlabour
●Workoffactoryemployeesthatcanbephysicallyanddirectlyassociatedwithconvertingrawmaterialsintofinishedgoodsisdirectlabour.
●Examplesinclude
⏹BottlersatCoca-Cola
⏹BakersatSaraLee
⏹Typesettersatanewspaper
ManufacturingOverhead
●Coststhatareindirectlyassociatedwithmanufacturingoffinishedgoods
●Allmanufacturingcoststhatcannotbeclassifiedasdirectmaterialanddirectlabour
●Examplesinclude:
⏹Indirectmaterials
⏹Indirectlabour
⏹Amortizationonfactorybuildings,insurance,taxes,maintenanceonfactoryfacilities.
Indirectmaterials
●Rawmaterialsthatcannotbeeasilyassociatedwiththefinishedproductarecalledindirectmaterials
●Indirectmaterialsdonotphysicallybecomepartofthefinishedproductorrepresenttoosmallapartofthefinishedproductintermsofcost
●Consideredpartofmanufacturingoverhead
●Examplesinclude:
⏹Lubricants
⏹Cleaningsupplies
⏹Polishingcompounds
Indirectlabour
●Workoffactoryworkersthathavenophysicalassociationwiththefinishedproduct,orforwhichitisimpracticaltotracetothegoodsproduced,isindirectlabour
●Examplesinclude:
⏹Wagesofmaintenanceworkers,janitors,andsecurityguards
⏹Supervisors
⏹Time-Keepers
PrimeCostsandConversionCosts
●Primecostsarethesumofalldirectmaterialscostsanddirectlabourcosts.Thesearealldirectmanufacturingcosts.
●Conversioncostsarethesumofalldirectlabourcostsandmanufacturingoverheadcosts,whichtogetherarethecostsofconvertingrawmaterialsintoafinalproduct.
ProductCosts
●Consistsofthedirectmaterialcost,thedirectlabourcost,andthemanufacturingoverheadcost
●Anecessaryandintegralpartofproducingtheproduct
●Recordedasinventorywhenincurred
●Donotbecomeexpenseuntilthefinishedgoodinventoryissold
PeriodCost
●Matchedwithrevenueofaspecifictimeperiodandchargedtoexoenseasincurred
●Non-manufacturingcosts
●Deductedfromrevenuesinperiodincurredtodeterminenetincome
●Includeall
⏹Sellingexpenses
⏹GeneralandAdministrativeexpenses
ProductversusPeriodCosts
CostBehaviourAnalysis
●Definition:
Thestudyofhowspecificcostsrespondtochangesinthelevelofbusinessactivity
●Somecostschange;othersremainthesame
●Helpsmanagementplanoperationsandmakedecisions
●Appliestoalltypesofbusinessesandentities
●Startingpointismeasuringkeybusinessactivities
●Activitylevelsmaybeexpressedintermsof
⏹Salesdollars(inaretailcompany)
⏹Kilometersdriven(inatruckingcompany)
⏹Roomoccupancy(inahotel)
⏹Danceclassestaught(byadancestudio)
●Foranactivityleveltobeuseful,changesinthelevelorvolumeofactivityshouldbecorrelatedwithchangesincost
●Theactivitylevelselectediscalledtheactivity(orvolume)index
⏹Identifiestheactivitythatcauseschangesinthebehaviourofcosts
⏹Allowscoststobeclassifiedaccordingtotheirresponsetochangesinactivityas:
VariableCost
FixedCost
MixedCost
VariableCost
●Coststhatvaryintotaldirectlyandproportionatelywithchangesintheactivitylevel
●Iftheactivitylevelincreases10%,totalvariablecostsincrease10%;iftheactivityleveldecreaseby25%,totalvariablecostswilldecreaseby25%
●Variablecostsalsoremainconstantperunitateverylevelofactivity
●Examplesofvariablecostsinclude:
⏹Directmaterialanddirectlabourforamanufacturer
⏹Salescommissionsforamerchandiser
⏹Gasolineinairlinesandtruckingcompanies
Examples:
◆DamonCompanymanufacturesratiosthatcontaina$10clock
◆Activityindexisthenumberofradiosproduced
◆Foreachradioproduced,thetotalcostoftheclocksincreasesby$10
✧If2,000radiosaremade,thetotalcostoftheclocksis20,000(2,000x$10)
✧If10,000radiosaremade,thetotalcostoftheclocksis$100,000
(10,000x$10)
FixedCosts
●Coststhatremainthesameintotalregardlessofchangesintheactivitylevel.
●Perunitcostvariesinverselywithactivity:
⏹Asvolumeincreases,unitcostdecline,andviceversa
●Examplesinclude:
⏹Propertytaxes
⏹Insurance
⏹Rent
⏹Amortizationonbuildingsandequipment
Examples:
◆DamonCompanyleasesitsproductivefacilitiesfor$10,000permonth
◆Totalfixedcostsofthefacilitiesremainconstantatalllevelsofactivity-$10,000permonth
◆Onaperunitbasis,thecostofrentdecreasesasactivityincreasesandviceversa
✧At2,000radios,theunitcostis$5($10,000÷2,000units)
✧At10,000radios,theunitcostis$1($10,000÷10,000units)
DistinguishBetweenVariableandFixedCosts
●Variablecostsarecoststhatvaryintotaldirectlyandproportionatelywithchangesintheactivitylevel.Thesecostsremainthesameperunitateverylevelofactivity.
●Fixedcostsarecoststhatremainthesameintotalwithintherelevantrangeregardlessofthechangesintheactivitylevel.Fixedcostsperunitvaryinverselywithactivity–inotherwordsasvolumeincreases,unitcostsdecreaseandviceversa.
RelevantRange
●Throughouttherangeofpossiblelevelsofactivity,astraight-linerelationshipusuallydoesnotexistforeithervariablecostsorfixedcosts
⏹Therelationshipbetweenvariablecostsandchangesinactivitylevelisoftencurvilinear
⏹Forfixedcosts,therelationshipisnonlinear–somefixedcostswillnotchangeovertheentirerangeofactivities,othersmaychangeatdifferentlevelsofactivity
●Definedastherangeofactivityoverwhichacompanyexpectstooperateduringayear
●Withinthisrange,astraight-linerelationshipusuallyexistsforbothvariableandfixedcosts
MixedCosts
●Coststhathavebothavariablecostelementandafixedcostelement
●Sometimescalledsemivariablecost
●Changeintotalbutnotproportionatelywithchangesinactivitylevel
High-LowMethod
●Mixedcostsmustbeclassifiedintotheirfixedandvariableelements
●Oneapproachtoseparatethecostiscalledthehigh-lowmethod
⏹Usesthetotalcostsincurredatboththehighandthelowlevelsofactivitytoclassifymixedcosts
⏹Thedifferenceincostsbetweenthehighandlowlevelsrepresentsvariablecosts,sinceonlyvariablecostschangeasactivitylevelschange
⏹Steps:
1.Determinevariablecostperunitusingthefollowingformula:
2.Determinethefixedcostbysubtractingthetotalvariablecostateitherthehighorthelowactivitylevelfromthetotalcostatthelevel
Example:
◆DataforMetroTransitCompanyforthelast4-monthperiod:
HighLevelofActivity:
April$63,000100,000km
LowLevelofActivity:
January30,00040,000km
Difference:
$33,00060,000km
1.Usingtheformula,variablecostsperunitare$33,000÷60,000=$.55variablecostperkm
ActivityLevel
High
Low
TotalCost
$63,000
$30,000
Less:
Variablecosts
(100,000x$.55)
55,000
(40,000x$.55)
22,000
Totalfixedcosts
$8,000
$8,000
2.Subtracttotalvariablecostsateitherthehighorlowactivitylevelfromthetotalcostatthatsamelevel
Example:
iftheactivitylevelis45,000km,theestimatedmaintenancecostswouldbe$8,000fixedand$24,750variable($.55x45,000km)foratotalof$32,750
ManufacturingCostsinFinancialStatement
Incomestatement
●Theincomestatementforamanufacturerissimilartothatofamerchandiserexceptforthecostofgoodssoldsection
CostsofGoodsSoldSectionoftheIncomeStatement
DeterminetheCostofGoodsManufactured
●WorkinProcess–partiallycompletedunitsofaproduct
●TotalManufacturingCosts–sumofdirectmaterialcosts,directlabourcosts,andmanufacturingoverhead,allincurredduringthecurrentyear
CostofGoodsManufacturedSchedule
BalanceSheet
Inventories
●Manufacturingcompaniesmayhavethreeinventoryaccounts:
⏹Rawmaterialsinventory–showsthecostofrawmaterialsonhand
⏹Workinprocessinventory–showsthecostapplicabletounitsonwhichproductionhasstartedbutisonlypartiallycomplete
⏹Finishedgoodsinventory–showsthecostofcompletedgoodsonhand
●Merchandisingcompanieshaveonlyonecategoryofinventory
⏹Merchandiseinventory
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