Managerial Accounting

MGT/ME/BME 6753
Fall 2018

Professor Arnold Schneider

Georgia Institute of Technology
Arnold.Schneider@scheller.gatech.edu
404-894-4907
 1

BASIC COST CONCEPTS

Financial vs. Managerial Accounting

Financial primarily concerned with outsiders
Managerial accounting primarily concerned with internal use.

Determining & Using Costs

Want to determine what things cost.

Cost Objects:
o Products
o Services
o Departments
o Programs
o Projects
o Activities

Reasons for Determining Costs

Different Costs for Different Purposes

Direct vs. Indirect (Common) Costs

Traceable to cost object Direct
Not traceable to cost object Indirect
 2

Example:
Following are costs incurred by the AmeriBell Co., a cellular
telephone manufacturer. For each, determine if the cost would be
a direct or indirect cost at the manufacturing plant level.
 President’s salary. - indirect
 Cost of telephone keypads. - direct
 Wages of assembly line workers. - direct
 Cost of utilities in the manufacturing plant. -direct
 Research and development costs. -indirect
 Cost of market research survey. -indirect

Manufacturing Costs
 Direct Materials
 Direct Labor
o Workers working directly on product
 Manufacturing Overhead
o All the manufacturing related costs
Non-manufacturing Costs
 Marketing
 Administrative

Product (Inventoriable) Costs  Mfg. costs

 3

Period (Non-inventoriable) Costs  Non-mfg. costs

o Not all costs have been incurred yet
o Far removed from products

Example:
Red, Inc. produced 100 pens in May, and sold 80 of 
them that month.  The remaining 20 were sold in June.

In May, factory heat cost $7,000 and heat for sales 
offices also cost $7,000.

Factory Heat­May Sales Office Heat­May
May: $5600 (product cost)(CGS) $7000 exp
$1400 Inventory
June: $1400 (CGS) ­­­­­­­­­­­­(fully expensed)

Product cost is an asset until it’s sold.

Balance Sheet for Mfg. Company

3 inventories: Raw Materials, Finished Goods, Work in Process

Income Statement for Mfg. Company

Merchandising: Cost of Goods Sold = B. Inventory + Purchases – E. Inventory
Manufacturing: Cost of Goods Sold = B. Inventory + CGM – E. Inventory
 4

Schedule of Cost of Goods Manufactured:

Direct Materials Used [= Beginning DM + DM Purchases – Ending DM]
+ Direct Labor
+ Mfg. Overhead
Mfg. Costs Incurred
+ B. WIP
- E. WIP
Cost of Goods Manufactured
 5

Case Study: Solar Technology

Solar   Technology   was   organized   at   the   beginning   of   the   current   year   to

produce and market a revolutionary new solar battery that is used in hand­held
cellular telephones.

“I   was   sure  that   when  our   battery  hit  the  market  it  would  be  an  instant
success,” said Roger Strong, founder and president of Solar Technology, Inc.  “But
just look at the gusher of red ink for the first quarter.  It’s obvious that we’re better
scientists than we are business people.”
The data to which Roger was referring follows:

Solar Technology, Inc.
Income Statement
For the Quarter Ended March 31

Sales   (32,000 batteries) $960,000

Less operating expenses:

Selling and administrative  salaries $110,000

Advertising 90,000
Maintenance, production 43,000
Indirect labor cost 120,000
Cleaning supplies, production 7,000
Purchases of r aw materials 360,000
Rental cost, facilities 75,000
Insurance, production 8,000
Depreciation, office equipment 27,000
Utilities 80,000
Depreciation, production equipment 100,000
Direct labor cost 70,000
Travel, salespersons 40,000

Total operating expenses 1,130,000

Net loss ($170,000)
 6

On April 3, just after the end of the first quarter, the finished goods storage area was swept by
fire and all 8,000 unsold batteries were destroyed. (These batteries were part of the 40,000 units
completed during the first quarter.) The company’s insurance policy states that the company will
be reimbursed for the “cost” of any finished batteries destroyed or stolen.

“We may not last a year if the insurance company doesn’t pay the $226,000 it owes us for the
8,000 batteries lost in the warehouse fire last week,” said Roger. “The insurance adjuster says
our claim is inflated, but he’s just trying to pressure us into a lower figure. We have the data to
back up our claim, and it will stand up in any court.”

Roger has determined this cost as follows:

Total costs for the quarter, $1,130,000 
­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­ =  $28.25 per unit
Batteries produced during the quarter, 40,000 

8,000 batteries x  $28.25  =  $226,000

The following additional information is available:

 There were no inventories at the beginning of the quarter. At the end of the quarter, 
inventories were as follows:  
o Raw materials, $10,000; 
o Work in process, $50,000; 
o Finished goods, ??

 80% of the rental cost was for production facilities and 90% of the utilities cost related to 
manufacturing operations.  The remaining amounts related to selling and administrative 
activities.
 7

1) What conceptual errors were made in preparing the income statement above?

2) Do you agree that the insurance company owes Solar Technology, Inc., $226,000?  
 8

Schedule of CGM for first quarter:

Cost per battery: 780k/40k batteries = 19.50

Finished goods inventory, 3/31: 19.5 * 8k = 156k

Correct income statement for the first quarter:

Sales  (32,000 batteries) $960,000
Less cost of goods sold:
Finished goods inventory, 1/1 $       ­0­
Add:  Cost of goods manufactured 780,000
Goods available for sale 780,000
Deduct:  Finished goods inventory, 3/31 156,000 624,000
Gross margin 336,000
Less operating expenses:
Selling and administrative salaries 110,000
Advertising 90,000
Rental cost, facilities  (20% X $75,000) 15,000
Depreciation, office equipment 27,000
Utilities  (10% X $80,000) 8,000
Travel, salespersons 40,000 290,000
Net income $46,000
 9

Difference of $216,000 in Net Income (from -$170,000 to +$46,000):

$10k + 50k + 156 K: RM at 3/31, WIP at 3/31, FG at 3/31
 10

Overhead Allocation
OH Rate: Total OH Cost / Total Activity

Example of OH rate: $500,000 / 50,000 hrs. = $10/hr.

Allocated OH = OH rate x Actual Activity

Short vs. Long Time Periods

Predetermined OH Rate: Est. OH Cost / Est. Activity

Applied OH = Predetermined OH Rate x Actual Activity

Example:
 For 2017, the budgeted overhead was $150,000 based on 60,000 labor hours. 

 Actual overhead was $158,000 and actual labor hours amounted to 62,000.

Predetermined OH Rate = 150k/60k = $2.50 /hour

Applied OH = $2.50 * 62k = $155k it’s less -> 3k of underapplied overhead

Adjustment of CGS – at the end of the year, add 
$3,000 to CGS because it’s underapplied

Plant­Wide Rate vs. Departmental Rates – separate 
overhead rate for each department. 
 11

Denominators:
 Ideal Capacity – maximum efficiency capacity with 
no downtime
 Practical Capacity – allows for normal amounts of 
downtime
 Expected Volume – based on expected demand, 
determine labor hours expected to work
 Normal Volume – normal volume takes average of 
last three or five years 
Most companies use expected volume. Gets in 
trouble when demand is falling. If expected 
volume goes down bc expected demand goes 
down, then predetermined overhead rate goes up.
When POR goes up, applied overhead goes up. 
Since the applied OH is part of the total product 
cost, the product cost goes up. When the cost is 
used to help set the product price, the product 
price goes up and further demand falls. Referred 
 12

to as the death spiral. In times of demand falling,
use practical capacity or normal volume.
 13

Activity­Based Costing (ABC)

ABC vs. Volume­based costing:

 Multiple cost drivers
 Departments vs. Activities – it’s really 
activities that are generated overhead 
costs. Purchasing, inspecting, setting up 
machines, etc.
 Volume­based vs. Activity­based cost 
drivers
oApplicability of DL with automation

Steps:
1. Identify cost pools.

2. Identify cost drivers.
 14

3. Determine separate cost rates for 
each pool & apply to each product.

ABC at HP:

# of Cost Cost per

Cost Driver Units Circuit
Activity Driver Rate for Board 67A Board
1. Purchasing # Parts in $0.10/part x 90 parts = $9.00
materials each board

2. Starting the # Boards in $1.00/board x 1 raw board = 1.00

product product

3. Inserting the # Insertions $0.20/ x 80 insertions = 16.00

components per board insertion

4. Soldering # Boards $3.00/board x 1 board = 3.00

soldered

5. Quality # Hrs board $70.00/hr x .20 hours = 14.00

testing is in testing

Total OH  = $43.00
 15

Example:
Gretzky Sporting Goods manufactures two types of ice hockey skates ­­ 
Regular and SuperPro. The following data have been obtained:

Regular      SuperPro
DM cost/unit $33.00 $38.00
DL cost/unit $32.00 $44.00
DL hours 12,000   3,000
Machine hours      2,000   4,000
Engineering hours      450      450
Number of setups          5        20
Number of units   8,000   2,200

The overhead costs consist of the following items:

Overhead Cost Item            Amount

 16

Setup costs                     $250,000

Engineering costs                      $180,000
Machine costs           $900,000
Total                   $1,330,000

Determine unit costs two ways:

1. Allocate OH using DL hours.
2. Allocate OH using ABC.
 17

1. Allocation using direct labor hours:

OH rate = $1,330,000 / (12,000 + 3,000) = $88.67 /
DLH

Regular: $33 + $32 + [$88.67(12,000)] / 8,000 = $198

SuperPro: $38 + $44 + [$88.67(3,000)] / 2,200 = $203

2. Allocation using ABC:

Setup rate = $250,000 / (5 + 20) = $10,000 / setup
Engineering rate = $180,000 / (450 + 450) = $200 /
e.h.
Machine rate = $900,000 / (2,000 + 4,000) = $150 /
m.h.

Regular: $33 + $32 +

[$10,000(5)+$200(450)+$150(2000)] / 8,000 = $120

SuperPro: $38 + $44 +

[$10,000(20)+$200(450)+$150(4000)] / 2,200 = $487

DLH ABC
Regular $198 $120
SuperPro $203 $487

Using DLH, Regular was overcosted, and SuperPro was

undercosted. Why?

The regular skate is producing 8,000. Almost four times

as many as superpro. And labor hours is four times as
much. The regular skate is the high volume skate.
However, the regular skate has much fewer setups,
fewer machine hours, and the same engineering hours.
 18

The superpro is much more complex to produce. ABC

captures this complexity.
 19

ABC for Non-Manufacturing Costs

ABC in Service Sector

Case Study: Thoracic Surgeons
Cost Objects
 
 
 
•  No­Charge Office Visits In Global Period  
•  Chargeable Office Visits
•  Chargeable Hospital Visits  
•   Surgeries

Activities
•Service Patients in Office
•Schedule & Perform In­office Surgeries
•Schedule & Coordinate Patients in Hospital or Other Facility
•Service Patients in Hospital or External Facility
•Obtain Insurance Authorization
•Maintain Medical Records
•Billing
•Collect Payments
•Resolve Collection Disputes and Re­Bill Charges
 20

•Provide Information to Third Parties
•Maintain Professional Education
•Sustain Business By Managing & Coordinating Practice 
•Maintain Facility
•Teaching and Research 
 21

Assigning Expenses to Activities:

EXPENSE COST DRIVER ASSIGN TO ACTIVITY #

Staff salaries -administrative/clerical % of employee time 1-14

(salary, payroll taxes, benefits, etc.) spent on each process

Occupancy costs: Direct 13 - Maintain Facility

(rent, depreciation, property taxes)

Utility cost; repairs & maintenance Direct 13 - Maintain Facility

Office/business equipment, & Direct 12 - Sustain Business

furniture
(lease payments or depreciation)
 22

Assigning Activities to Cost Objects:

Activities Cost Driver Cost Objects

1-Service Patients in Office # office visits No-charge office visits

Chargeable office visits

2-Service Patient in Hospital # primary surgeries Surgeries

3-Obtain Insurance Authorization # chargeable office visits + Chargeable office visits

Surgeries
(2 * # primary surgeries)

The surgeries are weighted by 2 to

reflect the greater amount of time
required for surgery authorization.
4-Maintain Medical Records # office visits + # hospital visits All cost objects
+ # primary surgeries
 23

Standard Costs & Cost Variances

Two cost components:

(1) Price
(2) Quantity

Actual Cost = Actual Price x Actual Quantity

Standards – what something should be

Standard Price = Budgeted Price
Standard Quantity ≠ Budgeted Quantity

Standard Quantity: the amount of input that should have

been used to produce the actual output
 24

Example for DM:

• 3 lbs. of steel for 1 trash can.
• 400 trash cans were budgeted.
• 450 trash cans produced.
• 1300 lbs. of steel used.

Actual quantity of DM = 1300

Budgeted quantity of DM = 1200 (400 cans * 3lbs per can)
Standard quantity of DM = 1350 (450 cans * 3 lbs per can)
 25

Example for DL:

• 4 hours of DL are needed to produce 1 printer
• Budgeted output was 200 printers
• Actual output was 220 printers
• 900 hours were worked

Actual hours = 400

Budgeted hours = 800 (200 * 4)
Standard hours = 880 (220 * 4)

Standard Cost = Standard Price x Standard Quantity

Setting Standards:
• Ideal (Strict) Standards
• Easily Attainable Standards
• Normal Operating Standards

For Standard Prices, Consider:

-- Shipping charges
-- Discounts

For Standard Quantities, consider:

Normal Breakage, Spillage, Theft, etc.

 26

Example:
• Greenbelt Inc. produced 200 quarts of a cleaning solvent.
• Each quart of solvent requires an input of 1.3 quarts of material (part of it is lost in
evaporation during production).
• The material is purchased in 15-gallon containers, at a cost of $45 per container.
• Discount terms of 2/10, n/30 are offered by the supplier. (invoice terms)(n = net) so it’s
due in 30 days
• Greenbelt takes all discounts.
Determine standard materials cost for the cleaning solvent.

Standard price( $45) (0.98) / (15 gallons)(4 quarts) = $0.735 /qt.

Standard quantity: 200 * 1.3 = 260 qts

Standard cost: $0.735 * 260 = $191 what it should have cost in materials to produce

Actual Cost Inputs at Standard Standard Cost

AQ x AP---------------------------------AQ x SP--------------------------------SQ x SP
AH * AR AH * SR SH * SR

DM Variances
Materials Price Variance = AQ (AP – SP)


o >0 => U
Materials Quantity Variance = SP (AQu – SQ)


o <0 => F
 27

DL Variances
Labor Rate Variance = AH (AR – SR)


Labor Efficiency Variance = SR (AH – SH)



Example
Standards for the direct costs of producing a bottle of medicine are:

Materials (6 ounces @ $3.25) $19.50

Labor (2 hours @ $9.50) $19.00

During March, 1200 bottles were produced and the following data recorded:
•
Materials -- purchased 8000 ounces @ $3.20 and used 7300 ounces
•
Labor -- paid an average of $9.70 for 2300 hours
MPV = 8,000 ( 3.20 – 3.25) = 400 F

MQV = 3.25 (7300 – 7200) = 325 U

LRV = 2300 (9.70 – 9.50) = 460 U

LEV = 9.50 ( 2300 – 2 * 1200) = -950

Causes of Variances
Variance Reporting

Revision of Standards
 28

Variance Investigation

Planning & Decision Making

Cost Behavior: Variable vs. Fixed Costs

Example:
Following are some costs incurred by the AmeriBell Company, a
cellular telephone manufacturer. For each cost, determine if the
cost would be considered a fixed or variable cost.
 President’s salary.

 Cost of telephone keypads.

 Wages of assembly line workers.

 Cost of utilities in the manufacturing plant.

 Research and development costs.

 Cost of market research survey.

Controllable vs. Noncontrollable
 Costs

Example:
Following are some costs incurred by the AmeriBell Company, a
cellular telephone manufacturer. For each cost, determine if the
 29

cost would be considered a controllable or noncontrollable

cost by the plant manager.
 President’s salary.

 Cost of telephone keypads.

 Wages of assembly line workers.

 Cost of utilities in the manufacturing plant.

 Research and development costs.

 Cost of market research survey.

Opportunity Cost

Sunk Cost
Any cost that has already been incurred is 
what we call a sunk cost.

Incremental (Differential) Cost 
{Incremental Revenue, Incremental Profit}
The cost of doing one alternative as opposed
to another
 30

Example
Item X:
Cost = $10/liter
Selling price = 17/liter
X can be made into Y for $6 extra and then sold for $28/liter

Incremental cost of converting X into Y = 6
Incremental revenue = 11
Sunk cost =
Opportunity cost of making Y =
Incremental profit from turning X into Y =

Relevant:
Future Costs & Revenues That Differ Among
Alternatives (Incremental Costs & Revenues)

Not relevant:
Sunk Costs
Future Costs That Do Not Differ Among
Alternatives
Rule About Sunk Costs Sometimes Violated

Relevance of:
-- DIRECT FIXED COSTS
:
 Avoidable
 31

 relevant
 Unavoidable – not relevant

-- COMMON (ALLOCATED) FIXED COSTS

Generally not relevant – the total cost will be the
same regardless of the decision
-- VARIABLE COSTS
Almost always relevant
-- OPPORTUNITY COSTS
EXAMPLE: SOURCING DECISION [Make vs. Buy]

JM Co. needs a subassembly for one of its helicopters. The total purchase cost would be 
$27,000. If they make it, the cost sheet would show:

DM $3,000
DL 14,000
Variable OH 1,000
Direct Fixed OH 5,000  (20% avoidable)
Allocated Fixed OH 6,000
$29,000

Determine relevant cost of making: 3k + 14k + 1k + 1k = 19k
19k < 27k  make
Suppose with the resources used to make the subassembly (e.g., space, workers, 
machines, etc.), JM Co. could produce something else that would have a profit of $9,000.
 32

Determine relevant cost of making: 19k + 9 k = 28k
28 k > 27k  buy
 33

EXAMPLE: Special Order Decision

Bernie’s Bakery currently sells 500 breads/day. Capacity is 750 breads/day.
Excess capacity of 250 breads

Price: $1.45
Ingredients & labor: $0.75
Variable overhead: $0.34
Fixed overhead: $0.19

Offer from outside the city: 300 breads @ $1.25
Should offer be accepted?

Incremental profit: 300 ( 1.25 – 0.75 – 0.34) – 50 ( 1.45 ­ .75 ­.34)
= $30

Since incremental cost is positive, it is worthwhile to accept a special order
 34

Example: Adding/Dropping a segment

ABCDE Department Store has five departments -- A, B, C, D, and E.

Department E's future is being evaluated using the data below:

All Others Dept. E Total

Sales................... $4,500,000 $ 500,000 $5,000,000
Cost of sales........... 2,200,000 300,000 2,500,000
Gross margin.......... $2,300,000 $ 200,000 $2,500,000
Rent and services....... $ 800,000 $ 200,000 $1,000,000
Direct salaries (avoidable)....... 450,000 50,000 500,000
Advertising expenses.... 450,000 50,000 500,000
Total expenses........ $1,700,000 $ 300,000 $2,000,000
Net profit (loss)....... $ 600,000 $(100,000) $ 500,000

Rent and services are corporate fixed expenses and are allocated evenly to the
five departments. Half of the advertising expenses vary with sales; the other half
will not change regardless of the decision and is allocated using sales dollars.

Should Dept. E be eliminated?

Dept. e
Sales 500k
Cost of sales (300k)
---
GM 200 k

Direct salaries (50k)

Advertising 25k (the half that varies with the sales is the relevant half, unavoid)
----
Incremental profit 125k +

So we keep the department

35