Midterm 1 Review
Chapter One: overview of managerial accounting
Accounting To provide stakeholders with useful
information about a business enterprise
Financial accounting To provide external users with useful financial
information in order to make investment and
Management accounting To provide internal user with financial
information and non-financial information as to
achieve the goals of the organization
Managerial Accounting Planning: Establishing goals and objectives, predicting results,
and drawing a detailed plan of who will do what, when and how to
achieve the desired goals.
Implementing the plan and decision making: Directing, Motivating
and measuring performance
Controlling and performance evaluation: Keeping the firm's
activities on track and ensuring that the plan has been followed in
the implementation process.
Agency theory: decision maker does not think about the company but only for themselves
Similarities and Differences between Financial and Managerial accounting
There are both similarities and differences between managerial and financial accounting.
o Both fields of accounting deal with the economic events of a business and require that
the results of that company's economic events be quantified and communicated to
o The two fields differ along several diminutions including: primary users of reports,
types and frequency of reports, purpose of reports, content of reports, and verification
process. Perspective Financial Accounting Managerial
Primary Users External users: Investors, Internal users: Managers of a
creditors, tax authorities. firm at all levels
Time Orientation (focus) Past Current &Future
Purpose of reports General Purpose to help Special-purpose for a
external users make particular user for a specific
investment & credit decisions. decision
Frequency of reporting Periodic (e.g. quarterly) As frequent as needed
Level of aggregation Aggregate Very detailed
Rules &Regulation of Regulated. Must follow GAAP No GAAP. Uses Cost---
Reporting Benefit concept
Guideline for judging Focus on Reliability Focus is on Relevance
usefulness of information
Verification process Independent Audit Internal Audit
Chapter Two: Intro to cost terms and purposes
Cost the value of economic resources (e.g., money) sacrificed or used up to
achieve a particular objective (e.g., produce a product or perform a service).
Cost object A cost object is anything for which a separate measurement of cost is desired
or needed (e.g., cost of a product, a machine, a service, or a process). The
cost can be identified
Cost Driver A cost driver is any activity (e.g., production volume) or factor (e.g., time) that
causes the total amount spent on a particular cost object to change. This
influences cost behaviour
Cost behaviour For the purposes of planning, control, and decision making, managers
need to understand how the TOTAL amount spent on a particular cost object
reacts to changes in a cost driver as measured, for example, by production or
sales volume. Cost Estimation Cost estimation is defined as the development of a well-defined relationship
between a cost object and its cost drivers, for the purpose of identifying cost
behavior and predicting future costs.
Cost assignment Cost assignment is the process of measuring the amount of costs
consumed by a particular cost object from the costs incurred
1. Cost accumulation: collection of cost data in some organized
means in an accounting system.
a. The cost incurred example the wood for furniture
2. Cost assignment/classification: is a general term that describes
the process of assigning (charging) costs incurred to a cost object.
a. Direct costs of a cost object are those costs that can be
traced easily to a cost object in an accurate and economically
feasible (cost-effective) way. E.g.: Direct materials costs , Direct
labor , can be traced directly to cost objects
b. Indirect costs of a cost object are related to the particular
cost object but cannot be traced to that cost object in an
economically feasible (cost-effective) way. Indirect costs,
therefore, should be allocated to the cost objects using an
allocation BASE factor. E.g. depreciation of machines,
maintenance cost, rent of the factory, and salary of supervisors,
Note the following:
1. The classification of costs into direct and indirect are defined with reference to a specific
cost object. A particular cost can be classified as direct with respect to a certain cost object
and indirect with respect to another cost object.
2. A cost would be considered indirect for one of two reasons: either it is impractical or it is
impossible to trace the cost to the cost object. For example, it could be possible to measure
the precise amount of nails or the amount of glue used on each table produced at a furniture
plant, but it wouldn’t be worth the effort. Instead, cost of nails and glue would typically be
considered an indirect material and would be included in overhead.
Uses of cost information 1. Product Costing: Product costing means calculating the
cost of production for the purpose of determining the Cost of
Goods Sold (CGS) for income determination and cost of
Ending Inventory to prepare the balance sheet. 2. Decision Making. Mangers need to make different types of
decisions to run the company. Each decision requires different
P-Costs a. Product Costs: Product costs are the costs charged to the units produced
as they are incurred. They become part of the cost of goods manufactured
and treated as inventory (i.e., asset) until they are sold. At this point, they
become cost of goods sold and charged to the income statement at the end
of the period. Balance sheet items, the assets
b. Period Costs. Period costs are expensed in the time period in which they
are incurred. All selling and administrative costs are typically considered to be
period costs. Income statement items, the expenses
Manufacturing costs 1.Direct Material
3.Indirect (overhead): indirect material, indirect labour and other
Direct cost=DM+DL Conversion cost=DL+MOH
T- Accounts and who they connect Some issue related to the cost of labour (MOH costs):
Idle time: represents the wages of direct labour workers who are idle due to machine
breakdowns, material shortages, power failures, and the like. Although the cost of the
idle time can be traced to direct labor, it should be treated as indirect labor added to
overhead, units are not being produced
Overtime premium: the wage rate paid to workers (for both direct labor and indirect
labor) in excess of their straight-time wage rates. Any overtime premium paid to
factory workers (direct as well as indirect labor) is usually considered to be part of
manufacturing overhead. However, if the customer is responsible for causing the
overtime, then the overtime premium paid to direct workers will be treated as direct
labor. Note that this case has to be explicitly stated, otherwise it should be treated
indirect labor. Usually calculated with time and a half Reasons for overtime:
-idle time causes overtime (overhead cost)
-customers may ask for overtime periods for quicker service, in this case it is direct
-bad scheduling (regular time is direct, overtime is indirect)
Labour fringe benefits: made up of employment related costs paid by the employer.
These costs are handled in two different ways by companies:
1. Many firms treat all such costs as indirect labor and add them to
2. Other firms treat the fringe benefits that relate to direct labor as additional
direct labor cost and those relate to indirect labor as FOH.
Classifying cost for decision making Variable cost: a cost that changes (increases and
decreases) in total in direct proportion to changes in
the related level of activity or volume. Total variable
costs for a given situation are equal to the number of
units multiplied by the variable cost per unit….each unit
-TVC is y-axis -units produced is x-
-positive and always beginning at the origin
Fixed cost: is a cost that remains unchanged in total
for a given time period, despite wide changes in the
related level of total activity or volume. As production
increases, total fixed costs stay the same within the
relevant range, but since we are dividing a constant
numerator [total fixed costs] by a progressively larger
denominator [total production or sales], the resulting
costs per unit become smaller and smaller. Each unit is
-TFC is the y-axis
-units produced is x –axis “Relevant Range” is the range activity during which the
relationship between the cost and cost driver remain
Mixed Cost: have characteristics of both fixed and variable
Step function: Another example of mixed cost. An
example of such cost behavior would be the total
salary expense for shift supervisors. If the factory runs
one shift, only one shift supervisor is required. In order
for the factory to produce above the maximum capacity
of a single shift, the factory must add a second shift
and hire a second shift supervisor, so that total shift
supervisor salary expense doubles. If the factory runs
three shifts, three shift supervisors are required.
-Total cost is y-axis
- units produced is x-axis
Chapter 10: Cost Estimation
Cost estimation the process of developing a well-defined functional relationship
between a cost object and its cost driver(s) in order to understand the
cost behavior. The purposes of cost estimation are:
(1) to identify the key cost drivers for each cost object to help
managers control costs
(2) to measure the variable and/or fixed components of the
cost item so as to help managers make correct decisions, and
(3) to predict its value in the future so as to help managers
correctly plan for the future.
Cost behaviours 1. The total cost may stay unchanged (fixed cost)
2. The total cost may change proportionately in response to the
change on the activity level (variable cost) 3. It may partially change proportionately and partially remain constant
How to estimate cost function: There are six steps in the cost estimation process
1. Define the Cost item to be estimated.
2. Determine the Cost Drivers.
3. Collect Consistent and Accurate Data.
4. Plot (Graph) the Data.
5. Select and Employ the Estimation Method.
6. Assess the Accuracy of the Cost Estimation
Linear Methods of cost estimation
(1) Changes in total costs can be explained by changes in the level of a single cost
(2) Cost behavior can adequately be approximated by a linear function of the activity
level within the relevant range
Basic Linear Function:
straight line equation as follows: y = a + b(x)
y = Total costs a = fixed cost component b = slope coefficient (variable cost rate)
x = the volume (quantity) of the cost driver
1. If the estimated value of a = 0 and b > 0 then we can conclude that the cost
behavior is Variable.
2. If the estimated value of b = 0 and a > 0 then we can conclude that the cost
behavior is Fixed. 3. If the estimated values of both a & b > 0 then we can conclude
that the cost behavior is Mixed.
High-Low (HL) Method
Assumption: only use one cost driver for hi-lo method
relationship between cost drivers are linear
1. Identify the highest value of volume (X) and its associated value of cost (Y) 2. Identify the Lowest value of volume (X) and its associated value of cost (Y)
3. Use the above two points to estimate the parameter b (variable cost per unit) in
the following cost function:
b = UVC= Slope = Change in cost (y) (Hy – Ly)
Change in volume (x) (Hx – Lx)
4. Estimate the Fixed component a as follows:
Substitute the value of b into the basic equation along with actual values of Y and X
at either the highest point or the lowest point into the following equation; then solve
for the intercept a:
y = a + b(x)
Total Cost (lowest cost driver level) = a + b(x at lowest quantity of cost driver)
Using the highest cost-quantity pair will give the same answer for the intercept.
5. Use the estimated cost function to predict future costs.
Major Weakness of High-Low Method:
1. H-L method uses only two data points and ignores the rest of the data.
2. H-L method could provide biased estimates if the two data points are outliers.
3. H-L method does not provide information to evaluate how good the estimated
function in representing the cost behavior or how accurate it is in predicting future
4. It allows only one independent variable to explain the behavior of cost.
Regression Analysis A statistical method for obtaining the unique cost-estimating equation
that best fits a set of data points. Regression analysis fits the data by