Managerial Accounting

Chapter 2
Managerial Accounting and
Cost Concepts
Faculty: Rezwanul Mumtahin Husain

After studying this chapter, you should

be able to understand
1.Manufacturing and nonmanufacturing cost
2.Product cost v/s Period cost
3.Prime cost and conversion cost
4.Schedule of Cost of goods manufactured

5.Variable cost v/s Fixed cost

6.Direct cost v/s Indirect cost
7.Differential cost, Sunk cost and Opportunity
cost

General cost classifications

In a manufacturing company costs are classified as
1.Manufacturing cost
2.Non-manufacturing cost

Manufacturing costs can be divided into three broad

categories:
1.Direct materials
2.Direct labor
3.Manufacturing overhead
Nonmanufacturing costs includes selling costs and
administrative costs.

Manufacturing cost
1. Direct materials: Materials that becomes an integral part of
the final product and whose costs can be conveniently traced
to the final product.
2.Direct labor: Labor costs that can be easily traced to the
individual units of product also known as touch labor.
3.Manufacturing overhead: It includes all manufacturing
costs except direct materials and direct labor. It is also known
as indirect manufacturing cost or factory overhead or burden.
Exp: Indirect materials, Indirect labor, depreciation,
maintenance and repairs.
-Prime costs and Conversion costs

Nonmanufacturing Costs
Selling costs: All costs that are incurred to secure
customer orders and get the finished products to the
customers.
Administrative costs: All executive, organizational and
clerical costs related with the general management of
the organization.
Nonmanufacturing costs are also known as the selling,
general and administrative costs (SG&A).

Product cost v/s Period cost

Product Cost
-All cost involved in acquiring and making a product.
-These costs are usually first assigned to inventories.
E.g. direct materials, direct labor and manufacturing
overhead

Period Cost
-All costs that are not part of the purchase and
manufacturing of goods
-Treated as an expense in the income statement.
E.g. rental cost and administrative cost

Manufacturing Costs
(Product costs)

Direct Labor

Direct Materials

Prime Cost

Manufacturing
Overhead

Conversion
cost

Nonmanufacturing costs
( Period costs or selling and
administrative costs)

Selling costs

Administrative
costs

Schedule of Cost of Goods Manufactured

Direct Materials:
Beginning RM Inventory

XXX

Add: RM Purchases

XXX
XXXX

Less: Ending RM Inventory

(XXX)

Raw material used in production

XXXX

Direct Labor

XXX

Manufacturing overhead

XXX

Total Manufacturing Costs

XXXX

Add: Beginning WIP Inventory

XXX

Less: Ending WIP Inventory

(XXX)

Cost of Goods Manufactured

XXXX

Cost Classifications for predicting Cost

Behavior
Variable Cost
-A cost that varies in total in direct proportion to changes in the
level of activity
-Variable cost per unit is constant

Fixed Cost
-A cost that remains constant in total regardless of changes in
level of activity
-Average fixed cost varies inversely with changes in the level of
activity

-Relevant range is the range of activity level within which

assumptions about fixed and variable costs are valid.

Cost Classifications for assigning costs to cost

objects
Cost Object: Anything for which you need to allocate costs.

Direct cost
These are costs that can be directly related to a specified cost object
E.g. direct materials and direct labor

Indirect cost
These are cost that cannot be easily and conveniently traced to a
specified cost objects because they act more like common costs.
E.g. a factory managers salary

Cost Classifications for Decision Making

1.Differential cost
2.Opportunity cost
3.Sunk cost

Differential cost
Cost between two alternative options
Company
ABC

Sell Directly
(Option A)

Sell through
Intermediary
(Option B)

Differential
Cost/Revenue

Revenues

700000

800000

100000

Total expenses

(540000)

(625000)

(85000)

Net Profit

160000

175000

15000

Opportunity cost
It is the potential benefit which is given up when
one alternative is selected over another.

Sunk cost
A cost that has already been incurred and cannot
be changed by any decisions made now or in the
future.

Cost summary and Classification Purpose

Cost classification

Purpose of cost classification

Product cost v/s Period cost

For the purpose of preparing

external financial statements

Variable cost v/s Fixed cost

For the purpose of predicting

cost behavior in response to
changes in activity

Direct cost v/s Indirect cost

For the purpose of assigning

cost to cost objects

Differential cost, Sunk cost and For the purpose of making

Opportunity cost
company decisions